This also provides cash for repayment to shareholders

We subtract post-tax interest and repaid debt from FCFF because this amount has been paid off to creditors out of FCFF. However, the company may also raise fresh debt during the year. It is therefore added in the calculation of FCFE.

It must be noted, that FCFF and FCFE are only estimates of what CAN go to debt and equity holders. They don’t represent what ACTUALLY goes to them. Free cash flows are therefore only a tool for assessing whether the company has generated enough cash to meet its obligations towards creditors and shareholders. It provides them an estimate of the company’s ability to cover its obligations towards them. FCFE on the other hand, is used by equity holders. It gives them an estimate of the safety of their dividend. Expected future values of FCFE are also used by equity investors to calculate the fair value of an equity share of the company. We will talk about this later, in the section on the relationship between stock price and dividends.

What next?

Now, we have a fair understanding of the parameters within which financial statements are prepared. This includes knowing what is accounting, understanding accounting rules and some basic accounting concepts such as IFRS and GAAP. We have also seen how the quality of financial reporting can be scrutinized. In the next section, we will look at the principal financial statements that companies release, and the information they contain. click here.

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