FCFF - why are accrued taxes and expenses added back to net income?

CFA Level II Equities
#1

Hi everyone – I’m working on reading 30 ‘Free Cash Flow Valuation’ in the official CFA books.

Had a question on practice problem 2: goal is to calculate FCFF from net income, given financial statements. One of the adjustments made to reach FCFF from net income is to add back ‘accrued taxes and expenses’.

Why is this done? I understand that since this is an increase in an expense item, it is a source of cash for the company. But I thought that only operating working capital was taken into account when making adjustments – are accrued taxes and expenses necessarily operating expenses?

Thanks for the help all.

#2

Accrued taxes and expenses are noncash. Noncash expenses are added back.

#3

I see. So these are not part of working capital, but rather noncash items like depreciation?

#4

They are part of working capital. But they’re noncash, which is why you add them back.

#5

S2000 - sorry for the back and forth. I thought that only the change in operating working capital is considered when calculating FCFF from net income which is why I am confused. Are these operating items?

I think my underlying confusion is that I am not sure what items should be included in working capital for the purposes of calculating FCFF. Should I include all items except for monetary items (changes in cash, changes in short term debt etc)?