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CFA Level II Exam · Free Cash Flow Valuation

How to Calculate FCFF and FCFE from Financial Statements

Updated 7 October 2026 · Fact-checked

FCFF is the cash available to all capital providers after tax, capex and working capital investment. FCFE is the cash left for shareholders after also paying interest and adjusting for net borrowing. Start from the figure the vignette gives, add back non-cash charges, subtract capex and working capital increases, then adjust for after-tax interest and net borrowing.

Understand Computing FCFF and FCFE from Financial Statements

Free cash flow to the firm (FCFF) is the cash generated by operations that is available to every investor in the firm: shareholders and debtholders. It is measured after tax and after the investment needed to keep the business running and growing. You discount it at the WACC to get firm value.

Free cash flow to equity (FCFE) is the cash left for shareholders after debtholders have been paid interest and after any change in debt. You discount it at the required return on equity to get equity value.

The two measures differ only by financing flows. Go from FCFF to FCFE by subtracting after-tax interest and adding net borrowing (new debt raised minus debt repaid). FCFF is before payments to debtholders, so you subtract interest net of the tax shield, Int(1 − t), to reach the cash flow available to equity holders. Going the other way, you add after-tax interest and subtract net borrowing.

The vignette may give you net income, EBIT, EBITDA or cash flow from operations (CFO). Each starting point sits at a different place on the income statement, so each needs different adjustments. For example, net income is after interest and tax, so you add back after-tax interest to reach FCFF. EBIT is before interest and tax, so you tax it and add back depreciation.

Two investments reduce free cash flow. Fixed capital investment (FCInv) is capex less proceeds from asset sales. Working capital investment (WCInv) is the increase in non-cash working capital, which excludes cash and short-term debt. An increase uses cash and a decrease releases it.

Key formulas to remember

FCFF from net income
FCFF = NI + NCC + Int(1 − t) − FCInv − WCInv
NCC is non-cash charges, mainly depreciation and amortization. Add back losses and subtract gains on asset sales, since the cash is in investing flows.
FCFF from EBIT
FCFF = EBIT(1 − t) + Dep − FCInv − WCInv
EBIT is before interest, so no interest adjustment is needed. Dep means depreciation and amortization.
FCFF from EBITDA
FCFF = EBITDA(1 − t) + Dep × t − FCInv − WCInv
Depreciation is added back only for its tax shield, because EBITDA already excludes the charge.
FCFF from CFO
FCFF = CFO + Int(1 − t) − FCInv
Working capital change and non-cash charges are already in CFO. Add back Int(1 − t) only when interest paid was deducted in CFO (US GAAP, or IFRS if classified as operating). Under IFRS, if interest paid is classified in financing, CFO is already before interest, so do not add it back.
FCFE from FCFF
FCFE = FCFF − Int(1 − t) + Net borrowing
Net borrowing = debt issued − debt repaid. It can be negative.
FCFE from net income
FCFE = NI + NCC − FCInv − WCInv + Net borrowing
Net income is already after interest, so no interest adjustment is needed.
FCFE from CFO
FCFE = CFO − FCInv + Net borrowing
The fastest route when CFO is given. This form applies when interest paid is already deducted in CFO (US GAAP, or IFRS if classified as operating). If under IFRS interest paid is classified in financing, subtract Int(1 − t) from CFO to get FCFE.
FCFF from FCFE
FCFF = FCFE + Int(1 − t) − Net borrowing
The same link as above, rearranged. Use it to check your answers.

How to solve Computing FCFF and FCFE from Financial Statements questions

Use this order for any question on computing FCFF or FCFE. It stops you mixing formulas.

  1. 1Read what the question asks for: FCFF or FCFE. Note the tax rate and whether the data are in one currency and one unit.
  2. 2Find the starting figure the vignette gives: net income, EBIT, EBITDA or CFO. Choose the formula that starts from it.
  3. 3List the adjustments that start point needs: non-cash charges, after-tax interest, capex, working capital change, net borrowing.
  4. 4Compute fixed capital investment as capex less proceeds from asset sales. Compute working capital investment as the change in non-cash working capital only. Use the sign correctly: an increase is a deduction.
  5. 5Compute net borrowing as debt issued minus debt repaid. Change in short-term debt counts as borrowing, not working capital.
  6. 6Calculate FCFF first if you can. Then move to FCFE by subtracting Int(1 − t) and adding net borrowing.
  7. 7Cross-check with a second route, such as FCFF = FCFE + Int(1 − t) − Net borrowing. Confirm the answer is in the units asked for.

Quickest way: Anchor on the given line and build outward

When to use it: Use it when the vignette gives several income statement and cash flow lines and you have little time. It works for all three-option questions on this topic.

  1. Circle the starting figure and the tax rate in the vignette.
  2. If it is CFO, first check where interest paid sits. If interest paid is deducted in CFO (US GAAP, or IFRS if classified as operating), use FCFE = CFO − capex + net borrowing, and for FCFF add Int(1 − t) to CFO and subtract capex. If IFRS classifies interest paid in financing, CFO is already before interest: FCFF = CFO − capex, and FCFE = CFO − Int(1 − t) − capex + net borrowing.
  3. If it is EBIT, compute EBIT(1 − t) + Dep − capex − WC increase. This is FCFF in one line.
  4. If it is EBITDA, compute EBITDA(1 − t) + Dep × t, then subtract capex and the WC increase.
  5. Move to FCFE with − Int(1 − t) + net borrowing.
  6. Eliminate options that differ only by a sign error or a missing tax adjustment.

Common mistakes in Computing FCFF and FCFE from Financial Statements

  • Adding back pre-tax interest instead of Int(1 − t) when moving from net income or CFO to FCFF.

    Students remember that interest is a financing flow and forget that it was tax-deductible.

    Fix: Always write Int(1 − t) in the formula. Interest is added back after tax because the tax shield stays in the cash flow.

  • Adding the full depreciation to EBITDA(1 − t).

    Students copy the EBIT formula, where depreciation is added in full.

    Fix: With EBITDA, depreciation enters only as Dep × t, its tax shield. Check by converting EBITDA to EBIT: EBITDA − Dep = EBIT.

  • Subtracting a decrease in working capital, or adding an increase.

    Students mix up balance sheet changes with cash flow effects.

    Fix: An increase in non-cash working capital uses cash, so subtract it. A decrease releases cash, so add it. Exclude cash and short-term debt from the calculation.

  • Subtracting net borrowing when computing FCFE from FCFF.

    Students think debt is an outflow, so they subtract it.

    Fix: Net borrowing adds to the cash available to equity, so it is added in moving from FCFF to FCFE: FCFE = FCFF − Int(1 − t) + Net borrowing. Debt repayment makes net borrowing negative.

  • Adding back non-cash charges that are already in CFO, or double counting working capital when starting from CFO.

    Students apply the net income formula to a CFO starting point.

    Fix: CFO already includes non-cash charges and working capital changes. Only subtract capex and adjust for interest or borrowing.

  • Ignoring gains and losses on asset sales when starting from net income.

    Students treat them as operating items.

    Fix: A gain is a non-cash item in net income, so subtract it from NCC. A loss is added back. The sale proceeds belong in fixed capital investment.

Worked examples

Example 1

Vignette: Norvik Plc reported EBIT of 480 million, depreciation of 120 million, capex of 200 million, and an increase in non-cash working capital of 30 million. Interest expense was 60 million and the tax rate is 25%. The company raised 90 million of new debt and repaid 40 million of debt. Questions: (1) What is FCFF? (2) What is FCFE? (3) What is FCFF computed from EBITDA?

Show the solution
  1. Q1: Tax EBIT: 480 × (1 − 0.25) = 360.
  2. Add depreciation and subtract capex and the working capital increase: 360 + 120 − 200 − 30 = 250.
  3. Q2: Net borrowing = 90 − 40 = 50. After-tax interest = 60 × 0.75 = 45.
  4. FCFE = 250 − 45 + 50 = 255.
  5. Q3: EBITDA = 480 + 120 = 600. Compute 600 × 0.75 = 450.
  6. Add the depreciation tax shield: 120 × 0.25 = 30. Then 450 + 30 − 200 − 30 = 250, which matches Q1.

Answer: FCFF = 250 million; FCFE = 255 million; FCFF from EBITDA = 250 million.

Example 2

Vignette: Sarnath Corp. (US GAAP) reported cash flow from operations of 900 million, after deducting interest paid of 100 million. Capex was 400 million, and there were no proceeds from asset sales. The tax rate is 30%. During the year it issued 150 million of debt and repaid 60 million. Questions: (1) What is FCFE? (2) What is FCFF?

Show the solution
  1. Under US GAAP, interest paid is deducted in CFO, so the add-back applies for FCFF and no further interest adjustment is needed for FCFE.
  2. With no asset sale proceeds, fixed capital investment equals capex: FCInv = 400.
  3. Q1: Net borrowing = 150 − 60 = 90.
  4. FCFE = CFO − FCInv + Net borrowing = 900 − 400 + 90 = 590.
  5. Q2: After-tax interest = 100 × (1 − 0.30) = 70.
  6. FCFF = CFO + Int(1 − t) − FCInv = 900 + 70 − 400 = 570.
  7. Check: FCFE + Int(1 − t) − Net borrowing = 590 + 70 − 90 = 570. This matches.

Answer: FCFE = 590 million; FCFF = 570 million.

Exam tips

  • Find the starting line first. The choice of formula follows from it, and many wrong options come from using the wrong formula.
  • Write the tax rate beside every interest or EBIT figure before you calculate. Missing the tax adjustment is the most common lost point.
  • If the vignette gives both a balance sheet and a cash flow statement, take capex from investing flows and the working capital change from the balance sheet or the CFO reconciliation. Do not mix them.
  • Always compute net borrowing from debt issued and repaid, and include any change in short-term debt. Then use the FCFF-to-FCFE cross-check when time allows.
  • Check the framework: under US GAAP interest paid is in CFO. Under IFRS it can be in operating or financing activities, so read the vignette before adding back.

Computing FCFF and FCFE from Financial Statements in other exams

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

Computing FCFF and FCFE from Financial Statements: frequently asked questions

How do I calculate FCFF from EBIT?

Use FCFF = EBIT(1 − t) + Depreciation − Capex − Increase in non-cash working capital. EBIT is before interest, so you do not adjust for interest. Tax EBIT first, then add back non-cash charges and subtract investment.

How do I calculate FCFE from FCFF?

Use FCFE = FCFF − Interest × (1 − t) + Net borrowing. Subtract after-tax interest because debtholders are paid first. Add net borrowing, which is debt issued less debt repaid.

What is the FCFF from EBITDA formula?

FCFF = EBITDA(1 − t) + Depreciation × t − Capex − Increase in non-cash working capital. Depreciation appears only as a tax shield because EBITDA is calculated before it. If you convert to EBIT first, you get the same answer.

Is working capital change from the balance sheet or the cash flow statement?

Either works if you use non-cash working capital only. Exclude cash and short-term debt. If you start from CFO, working capital changes are already included and you do not subtract them again.