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CFA Level I Exam · Analyzing Statements of Cash Flows II

FCFF and FCFE Formulas: How to Calculate Free Cash Flow

Updated 7 October 2026 · Fact-checked

FCFF is the cash available to all capital providers, both debt and equity, after operating costs, taxes and investment. FCFE is the cash left for shareholders alone after debt service and net borrowing. Pick the formula that matches your starting number (net income, CFO or EBIT), then adjust for interest, capex, working capital and borrowing.

Understand Free Cash Flow to the Firm and to Equity

Free cash flow is cash a company generates after paying for the investment it needs to keep operating and growing. It is what is left over for the people who funded the business.

FCFF (free cash flow to the firm) is the cash available to all capital providers: bondholders and shareholders. It is measured before any payments to them. So FCFF does not depend on how the firm is financed.

FCFE (free cash flow to equity) is the cash available to common shareholders only, after interest, debt repayments and new borrowing. It depends on the firm's financing choices.

The link is simple. Start with FCFF, take away the after-tax interest paid to lenders, and add net borrowing. Net borrowing is new debt issued minus debt repaid. That gives FCFE.

The exam gives you different starting points, such as net income, CFO or EBIT. Each has its own formula, but all give the same answer when the data are consistent. Your job is to pick the right one and adjust only for what the starting number has not already captured.

Key formulas to remember

FCFF from net income
FCFF = NI + NCC + Int(1 − t) − FCInv − WCInv
NCC is non-cash charges such as depreciation and amortization. FCInv is fixed capital investment (capex net of asset sales). WCInv is the increase in working capital.
FCFF from CFO
FCFF = CFO + Int(1 − t) − FCInv
Use when interest paid is in CFO, as US GAAP requires and IFRS allows. CFO already includes the working capital change. If interest paid is in financing under IFRS, CFO is before interest, but the taxes paid in CFO still reflect the interest deduction. You must remove that tax saving, so FCFF = CFO − Int × t − FCInv.
FCFF from EBIT
FCFF = EBIT(1 − t) + Dep − FCInv − WCInv
Dep is depreciation and amortization. Tax is applied to EBIT, so no interest adjustment is needed.
FCFF from EBITDA
FCFF = EBITDA(1 − t) + Dep × t − FCInv − WCInv
Depreciation is added back only for its tax shield, Dep × t.
FCFE from CFO
FCFE = CFO − FCInv + Net borrowing
Net borrowing = debt issued − debt repaid. This assumes interest paid is in CFO, so CFO is already after interest. If interest paid is in CFF under IFRS, CFO is before interest, so also subtract after-tax interest: FCFE = CFO − Int(1 − t) − FCInv + Net borrowing.
FCFE from FCFF
FCFE = FCFF − Int(1 − t) + Net borrowing
Subtract after-tax interest because lenders are paid before shareholders.

How to solve Free Cash Flow to the Firm and to Equity questions

Use this order for any FCFF or FCFE question. It stops you from adding or subtracting the same item twice.

  1. 1Read what the question asks for: FCFF or FCFE. Note the tax rate and whether interest paid sits in CFO.
  2. 2Identify your starting number: net income, CFO, EBIT or EBITDA.
  3. 3Choose the matching formula from the list. Do not mix two formulas.
  4. 4Add back non-cash charges only if your starting figure is after them (net income). Skip this if you start from CFO.
  5. 5Deduct fixed capital investment. Deduct the increase in working capital if the starting number does not already include it (not needed from CFO).
  6. 6For FCFF, add after-tax interest if starting from net income or CFO (with interest in CFO). For FCFE from FCFF, subtract after-tax interest and add net borrowing.
  7. 7Check the answer: FCFE should equal FCFF − Int(1 − t) + Net borrowing. Then match it to one of the three options.

Quickest way: Start from CFO and bridge

When to use it: Use when the question gives CFO and capex, which is common, and interest paid is in CFO. It is the shortest route to either measure.

  1. FCFE = CFO − capex + net borrowing. This is one line. If interest paid is in CFF, also subtract interest × (1 − t).
  2. FCFF = CFO + interest × (1 − t) − capex. Add the after-tax interest back. If interest paid is in CFF, do not add it back.
  3. If you are given FCFF and asked for FCFE, subtract interest × (1 − t) and add net borrowing.
  4. Compare with the three options. Wrong choices usually come from skipping the tax adjustment or the borrowing term.

Common mistakes in Free Cash Flow to the Firm and to Equity

  • Adding back full interest instead of after-tax interest

    Students remember that interest is a financing cost and forget the tax shield.

    Fix: Always use Int(1 − t). Interest of 40 at a 30% tax rate adds back 28.

  • Adding interest back to CFO when going to FCFE

    The FCFF formula is memorized and applied to both measures.

    Fix: FCFE is after interest. When interest paid is in CFO, CFO is already after interest, so use CFO − FCInv + Net borrowing. If interest paid is in CFF under IFRS, CFO is before interest, so also subtract Int(1 − t).

  • Subtracting working capital again when starting from CFO

    Students copy the net-income formula, which has a WCInv term.

    Fix: CFO already reflects working capital changes. Deduct only capex.

  • Ignoring net borrowing in FCFE

    Students stop once they reach a number that looks like free cash flow.

    Fix: Net borrowing = issued − repaid. Repayments reduce FCFE, new debt increases it.

  • Adding back all of EBITDA depreciation, not just the tax shield

    From EBIT the formula adds Dep, so the EBITDA version is confused with it.

    Fix: From EBITDA, use EBITDA(1 − t) + Dep × t. EBITDA is before depreciation, so only the tax saving is added.

  • Treating a negative working capital change as an outflow

    Sign confusion between 'change in working capital' and 'investment in working capital'.

    Fix: WCInv is an increase in working capital and reduces cash. A decrease in working capital adds cash.

Worked examples

Example 1

A company reports net income of €200 million, depreciation of €50 million and interest expense of €40 million. The tax rate is 30%. Fixed capital investment is €80 million, the increase in working capital is €20 million, and net borrowing is €30 million. What is FCFE? A. €150 million B. €178 million C. €180 million

Show the solution
  1. First find FCFF = NI + NCC + Int(1 − t) − FCInv − WCInv.
  2. After-tax interest = 40 × (1 − 0.30) = 28.
  3. FCFF = 200 + 50 + 28 − 80 − 20 = 178.
  4. FCFE = FCFF − Int(1 − t) + Net borrowing = 178 − 28 + 30 = 180.
  5. Check: option A (150) leaves out net borrowing, and option B (178) is FCFF.

Answer: C. FCFE = €180 million. Directly: NI + NCC − FCInv − WCInv + Net borrowing = 200 + 50 − 80 − 20 + 30 = 180.

Example 2

A firm reports CFO of $500 million, including interest paid of $60 million. Under IFRS, the firm classifies interest paid in operating activities (CFO), so CFO is already after interest. The tax rate is 25%, capital expenditure is $220 million and net borrowing is $40 million. What is FCFE? A. $280 million B. $320 million C. $325 million

Show the solution
  1. Interest paid is classified in CFO, so CFO is already after interest. The shortcut applies: FCFE = CFO − FCInv + Net borrowing.
  2. FCFE = 500 − 220 + 40 = 320.
  3. Cross-check through FCFF: after-tax interest = 60 × 0.75 = 45.
  4. FCFF = 500 + 45 − 220 = 325.
  5. FCFE = 325 − 45 + 40 = 320, which agrees.
  6. Option A (280) leaves out borrowing. Option C (325) is FCFF.

Answer: B. FCFE = $320 million.

Exam tips

  • Look at the first number in the question. It tells you which formula to use, and it tells you which adjustments are already done.
  • Compute both FCFF and FCFE when time allows. The cross-check FCFE = FCFF − Int(1 − t) + Net borrowing catches errors fast.
  • Watch for the words 'net borrowing', 'repaid' and 'issued'. Compute the net figure before using it.
  • With three options and no penalty for wrong answers, the usual distractors are FCFF in place of FCFE, or pre-tax interest. Eliminate those first.
  • Check whether interest paid is in CFO or CFF. Under IFRS it can be either, so the question will state it. The CFO-based FCFE shortcut assumes interest is in CFO; if it is in CFF, also subtract after-tax interest.

Practice questions from Analyzing Statements of Cash Flows II

Free Cash Flow to the Firm and to Equity in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

Free Cash Flow to the Firm and to Equity: frequently asked questions

What is the difference between FCFF and FCFE?

FCFF is cash available to all capital providers, before payments to lenders. FCFE is cash available to shareholders only, after interest and net borrowing. FCFF is discounted at WACC to get firm value, while FCFE is discounted at the cost of equity to get equity value.

How do I calculate FCFF from CFO?

If interest paid is in CFO, add after-tax interest to CFO and subtract fixed capital investment: FCFF = CFO + Int(1 − t) − FCInv. Do not subtract working capital again, since CFO already reflects it. If interest paid is classified in financing under IFRS, CFO is before interest, but the taxes paid in it already reflect the interest deduction. Remove that tax saving: FCFF = CFO − Int × t − FCInv.

How do I get FCFE from FCFF?

Subtract after-tax interest and add net borrowing: FCFE = FCFF − Int(1 − t) + Net borrowing. For example, FCFF of 178, interest of 40 at a 30% tax rate and net borrowing of 30 gives 178 − 28 + 30 = 180.

Why is depreciation added back in the net income formula?

Depreciation reduces net income but is not a cash outflow. Adding it back restores the cash. The actual cash spent on assets is captured separately in fixed capital investment.