S2000 magician please help me
On fcff formula for net income it seems like we are adding net income twice. Once as ncc and another as adding to fci investment. I don’t understand why. You briefly explained this on another post. Could you pls explain again? Thank u so much
I understand why depreciation is being added to net pp&e because ideally we should be taking into account changes in gross pp&e to account for changes fci inv. If so what is the difference between depreciation added as ncc vs depreciatin added to in capital. Isn’t that double counting.
THe formula is :
FCFF = NI + NCC +Int(1-T) - WCi - FCi
Here, NCC is depreciation
Equivalently, and to make it easier to see… I’m just going to part the FCi and Depreciation part:
FCFF = NI - (FCi - Depreciation) … = NI - FCi + Depreciation
Thanks but that’s not what I’m after. Can u offer an intuitive explanation
Let me restate. If we look at just the fci investments part I understand why depreciation is added back. I’m trying to understand this in the whole context of the formula. If we are already adding back non cash charges to net pp&e why add it again as ncc in the beginning of the formula?
I think I got this. Basically i was ignoring the - sign in front of fci investments. So we are not double counting twice. We are adding ncc in the beginning and in fci investments but fci inv is getting subtracted as a whole so basically net depreciation expensed added within the formula is 0.
Do you guys know what an accrual is? Accrued Sales and Accrued Expenses are fundamental in building financial statements. The rule of accruals in accounting states that we account sales and expenses when made, not just necessarily when paid. For example: I sell smartphones totally on credit, so my sales are $100 but my cash inflow is $0 until I receive the money (probably months ahead). In the Balance Sheet you will see 0 variation in cash and banks account but $100 increase in Receivables account.
Also, do you know how many methods are there to build a cash flow? Yeah, Direct and Indirect Method.
The method this formula "FCFF = NI + NCC +Int(1-T) - WCi - FCi " is applying is the indirect method for calculating cash flows.
The indirect method supposes that we start building the cash flow from the Income Statement bottom line, i.e. Net Income.
As we know the income statement is built under the accrual rule for sales and expenses, we must revert all the non-cash charges the income statement includes: for example depreciation, amortization, gains and loses when assets sold, and changes in Working Capital Accounts. Check the book for more examples!
In the case of depreciation and amortization (most common NCC, but not the only one), they are deducted as expenses in the income statement. But they are not cash outflows, so we revert them adding them back to net income. As easy as that, no tricks, no weird formulas.
If we continue my first numeric example, the change in WC investments (WCi) would be -100 right? Because, remember, the net income is including a sale of $100, but not cash involved (full credit), so I retire them.
In real life, changes in WCi includes from 5 up to 15 accounts easily, but for the exam you will se max 3 or 5, so not despair 
Hope this help you understanding a little bit more how this works. Any question please ask.
I have a question… why are gains on sale of long-lived assets and losses of sales of long lived assets non cash charges ??? Could you please make an example??? And how are those both different from FCInv = capex - proceeds from sale of LT assets??? Thank you Harrogat
Simply because the cash that the company receives (the proceed) from the sale of fixed (LT) assets is considered as a cash inflow in the Cash Flow From Investing Activities (FCInv). So, since we are using the Indirect Method for calculating cash flows, NI is already carrying the gain or loss in the sale of those LT assets. Have you seen it yet?
This formula FCFF = NI + NCC +Int(1-T) - WCi - FCi is considering NI and FCInv at the same time, so if we don’t adjust the gain or loss into NCC, we would be double-counting the gain or loss because obviously the cash proceed of the sale already includes the gain or the loss
First of all, how the accounting gain or loss is calculated? The balance sheet carries the asset at depreciated value or fair value (market value). Suppose we sold the company transport truck for 1,000 and the balance sheet value of the truck was 800. So we made a profit of 200. The 1,000 cash will go to FCInv as +1,000 inflow and the 200 gain will go to the Income Statement as a gain from sale of LT asset in a line below operating profit (because this is not an operating revenue, but an extraordinary income).
Note the 1,000 amount includes the gain as I said above !
If we calculate FCFF without considering the subtraction of the 200 gain as negative NCC, we would sum a NI that includes a 200 gain and a FCInv of +1,000 that also includes the 200 gain. Double counted the gain.
In case we want to calculate Operating Cash Flow (CFO), the adjustment is the same, we also deduct the 200 gain. But the reason this time is that that gain comes from a non-operating activity, so we exclude the amount.
The same analysis apply for the case when we sell the asset at loss, the signs are reversed.
A numeric example:
Continuing with the truck example, also assume NI is 500, there are no other NCC than the gain in the sale of the truck, interest expense is zero and Working Capital Investments are zero (WCi).
FCFF = 500 - 200 + 1,000 = 1,300
Remember that 500 already includes the 200 gain, so I subtract the amount and let the 1,000 carry the gain.
Any questions, please ask
Wow, great response. You are great mi amigo del alma
De nada compañero.
Always happy to help