Free cash flow (FCF) is a key metric to understand a company’s actual cash generation, beyond what net profit shows. It’s critical for valuing businesses using discounted cash flow (DCF) analysis. Here’s how you can calculate FCF in 5 steps:

1. Choose the Right FCF Type:
   • Use FCFF (Free Cash Flow to the Firm) to value the entire business.
   • Use FCFE (Free Cash Flow to Equity) to focus on equity shareholders.
     Always pair FCFF with WACC (Weighted Average Cost of Capital) and FCFE with the cost of equity.
2. Calculate Operating Profit and Adjust for Taxes:
   • For FCFF, start with EBIT (Earnings Before Interest and Taxes) and calculate NOPAT (Net Operating Profit After Tax):
     NOPAT = EBIT × (1 – Tax Rate).
   • For FCFE, use net income directly.
3. Add Back Non-Cash Charges:
   • Include depreciation, amortisation, impairment charges, and other non-cash items from the cash flow statement.
4. Adjust for Changes in Working Capital:
   • Calculate the change in net working capital (NWC):
     ΔNWC = NWC (current year) – NWC (previous year).
   • An increase in NWC reduces FCF, while a decrease adds to it.
5. Subtract Capital Expenditures (Capex):
   • Find Capex in the cash flow statement under “Investing Activities”.
   • Subtract Capex from the adjusted cash flow to complete the FCF calculation.

Example Formula:

• FCFF:
  FCFF = NOPAT + Non-Cash Adjustments – ΔNWC – Capex
• FCFE:
  FCFE = Net Income + Non-Cash Adjustments – ΔNWC – Capex + Net Borrowing

By following these steps, you can estimate a company’s cash flow and use it for DCF analysis to assess its valuation. This method gives a clearer picture of financial health than relying on profit metrics alone.

Step 1: Choose the Right Free Cash Flow Type and Gather Financial Data

Before diving into your DCF model, you need to decide whether to use FCFF or FCFE, as this decision influences both the data you’ll need and the discount rate you’ll apply.

FCFF vs. FCFE

FCFF (unlevered free cash flow) reflects the cash available to all capital providers – both debt holders and equity shareholders – before accounting for interest payments. This makes it independent of the company’s financing structure. It’s discounted using the Weighted Average Cost of Capital (WACC) to calculate enterprise value. From there, you subtract net debt to determine equity value.

FCFE (levered free cash flow), on the other hand, is the cash available exclusively to equity shareholders. It accounts for interest payments, debt repayments or issuances, and other financing activities. Since FCFE already includes the effects of debt, it is discounted using the cost of equity, directly yielding equity value.

FCFF is often the go-to choice for valuing an entire business, especially if the company’s capital structure might change in the future or when comparing businesses with varying levels of debt. For instance, if you’re evaluating a capital-intensive industrial company listed on the SGX that may adjust its borrowings as it grows, FCFF ensures the valuation remains unaffected by financing decisions. On the other hand, FCFE is more appropriate if you’re focused solely on equity value and the company’s capital structure is stable and predictable.

One important rule: don’t mix cash flow types with the wrong discount rates. Use WACC for FCFF and cost of equity for FCFE.

If you’re new to DCF modelling, starting with FCFF is often simpler. It avoids the complications of forecasting net borrowing year by year. You can always calculate equity value by subtracting net debt from enterprise value at the end.

Once you’ve selected the cash flow type, the next step is gathering accurate financial data from the company’s core statements.

Where to Find Financial Data

A reliable DCF analysis hinges on accurate financial data. For SGX-listed companies, you’ll find the necessary information in their income statements, cash flow statements, and balance sheets.

Start by downloading the company’s annual report and its latest quarterly results. These are available on the SGX company announcements page (via the SGX RegCo website) and the company’s Investor Relations section. Use the most recent full-year audited figures as the foundation for building a multi-year forecast.

From the income statement, focus on:

• Revenue to assess top-line growth trends.
• EBIT (operating profit) as the starting point for calculating NOPAT (Net Operating Profit After Tax) when using FCFF.
• Income tax expense and the effective tax rate (income tax expense divided by profit before tax) for tax adjustments.
• Net income attributable to shareholders, which serves as the base figure for FCFE calculations.

From the cash flow statement, gather:

• Cash flow from operations (CFO) to get an overview of cash generated by the business.
• Depreciation and amortisation (D&A) and other non-cash adjustments like impairments or share-based payments, which may need to be added back.
• Capital expenditures (Capex), often listed as “Purchase of property, plant and equipment” or “Additions to PPE”.
• For FCFE, note net borrowing (new debt raised minus debt repaid), typically found in the financing section.

From the balance sheet, extract:

• Current assets (e.g., trade receivables, inventories) and current liabilities (e.g., trade payables, short-term borrowings) to calculate net working capital (NWC) and track its changes over time.
• Interest-bearing debt (short-term and long-term) and cash and cash equivalents, which are used to compute net debt when converting enterprise value to equity value in an FCFF calculation.

Most SGX-listed companies report their financials in Singapore dollars (SGD), so ensure all your inputs and projections are consistent in currency. Also, review the notes to the financial statements for additional details like segment performance, depreciation schedules, or explanations of unusual items.

Before entering data into your DCF model, clean and normalise it. Remove items like one-off gains, major restructuring costs, or asset impairments that don’t reflect the company’s regular operations. For example, if an SGX industrial company sold a piece of land and recorded a large gain, exclude that gain from your EBIT baseline when forecasting future cash flows. These adjustments will give you a clearer picture of the company’s ongoing performance and lead to more dependable valuations.

Step 2: Calculate Operating Profit and Apply Tax Adjustments

Once you’ve gathered the financial data, the next step is to calculate the after-tax operating profit. This is where you decide whether to use EBIT (Earnings Before Interest and Taxes) for FCFF or net income for FCFE. The choice depends on what you’re valuing: FCFF focuses on the entire business, independent of financing, and starts with operating profit before interest. On the other hand, FCFE values just the equity portion, beginning with net income after all obligations, including interest, have been met. This step is critical for laying the groundwork for accurate free cash flow (FCF) projections and ensuring smooth adjustments later.

Calculating NOPAT for FCFF

For FCFF, the key figure to calculate is NOPAT (Net Operating Profit After Tax). NOPAT represents the company’s operating profit after accounting for taxes but excludes interest. This approach ensures that your valuation remains unaffected by the company’s financing methods, which is important when valuing the entire business.

The formula for NOPAT is simple:

NOPAT = EBIT × (1 – Tax Rate)

Start with EBIT, which is often labelled as “Operating Profit” in financial reports for SGX-listed companies. This figure reflects the profit generated from core operations before considering financing decisions.

For the tax rate, use the company’s effective tax rate instead of the standard 17% corporate tax rate in Singapore. The effective tax rate (calculated as income tax expense ÷ profit before tax) provides a clearer picture of the actual tax burden, factoring in tax incentives, overseas operations, and other adjustments.

Here’s a practical example (in S$ millions):

• EBIT: S$8.0
• Interest expense: S$1.0
• Pre-tax income: S$7.0
• Income tax expense: S$1.19
• Net income: S$5.81

First, calculate the effective tax rate: S$1.19 ÷ S$7.0 = 17%.
Next, apply the NOPAT formula: S$8.0 × (1 – 0.17) = S$8.0 × 0.83 = S$6.64 million.

Notice that NOPAT (S$6.64 million) is higher than net income (S$5.81 million). That’s because NOPAT excludes the S$1.0 million interest expense, treating the company as if it had no debt. This makes NOPAT the right starting point for unlevered free cash flow, which values all capital providers, including both debt holders and equity shareholders.

For future forecasts, you might want to use a normalised tax rate instead of the latest effective rate, especially if the current year includes one-off tax adjustments. A statutory rate of 17% is often used for mature Singapore-based companies. However, if significant profits come from overseas, a blended rate may be more accurate. For example, if 60% of profits are taxed at 17% in Singapore and 40% are taxed at 25% abroad, the blended rate would be (0.6 × 17%) + (0.4 × 25%) = 20.2%.

Before calculating NOPAT, ensure the EBIT figure reflects only core operating activities. Exclude one-off items like a S$500,000 gain from selling machinery. This adjustment ensures that NOPAT – and your free cash flow forecasts – accurately represent sustainable operations rather than temporary gains.

Using Net Income for FCFE

For FCFE, the starting point is net income attributable to common shareholders. This figure already accounts for interest, taxes, and expenses, making it a straightforward base for FCFE calculations.

Net income is typically found at the bottom of the income statement, labelled as “Profit Attributable to Shareholders” or “Net Profit After Tax” in SGX reports. Unlike NOPAT, net income reflects the company’s actual capital structure since interest expenses have been deducted.

Using net income (S$5.81 million) as the base, you’ll then adjust for factors like non-cash items, working capital changes, capital expenditures (Capex), and net borrowing to arrive at FCFE.

Just like with EBIT for NOPAT, it’s important to clean up net income before using it. For instance, if the company reports net income of S$2.5 million but this includes a one-time property sale gain of S$300,000, the adjusted net income for FCFE calculations would be S$2.2 million. Using unadjusted figures can distort your valuation by misrepresenting the cash available to shareholders.

The key difference between NOPAT and net income lies in their focus. NOPAT ignores financing to value the entire business, while net income factors in financing costs to specifically value equity. This distinction also affects the discount rate: FCFF (based on NOPAT) uses WACC (Weighted Average Cost of Capital), which considers both debt and equity costs, whereas FCFE (based on net income) is discounted using the cost of equity.

For many Singaporean investors building DCF models, starting with NOPAT for FCFF is often more practical. It avoids the challenges of forecasting debt level changes year by year and keeps the valuation free from leverage effects. You can calculate equity value later by subtracting net debt from the enterprise value.

Remember: use WACC for FCFF and the cost of equity for FCFE.

With your after-tax operating profit calculated, the next step is to adjust for non-cash charges that impacted reported profit but didn’t actually consume cash.

Step 3: Add Back Non-Cash Charges

Once you’ve adjusted for taxes and operating profit, the next step in refining your free cash flow estimate is to reintroduce non-cash charges. This process helps reveal the actual cash flow by accounting for items that reduce reported profits but don’t involve any real cash outflow.

For example, after calculating your after-tax operating profit, you’ll need to add back non-cash charges like depreciation and amortisation. These charges reduce the profit shown on the income statement but don’t reflect actual cash spent during the period. Imagine a company buys a machine for S$500,000, which is then depreciated over its useful life. While this depreciation reduces profits, it doesn’t involve any cash leaving the business. By adding it back, you get a clearer picture of the free cash flow.

This adjustment is crucial for both Free Cash Flow to the Firm (FCFF) and Free Cash Flow to Equity (FCFE). Whether starting from NOPAT (for FCFF) or net income (for FCFE), these non-cash items need to be accounted for.

Example with Singapore Dollar Figures

Let’s break this down with a simple example:

• Revenue: S$1,000,000
• Cash operating expenses: S$700,000
• Depreciation & amortisation: S$100,000
• Tax rate: 17%

First, calculate the accounting EBIT:
S$1,000,000 – S$700,000 – S$100,000 = S$200,000

Next, determine NOPAT:
S$200,000 × (1 – 0.17) = S$166,000

Finally, add back depreciation to calculate operating cash flow:
S$166,000 + S$100,000 = S$266,000

Even though the after-tax profit is S$166,000, the operating cash flow jumps to S$266,000 because the S$100,000 depreciation didn’t involve any cash outlay.

Key Non-Cash Items to Consider

Here are some common non-cash charges you’ll encounter:

• Depreciation: A major adjustment in capital-heavy industries like manufacturing, telecommunications, and real estate. It spreads the cost of physical assets over their useful lives.
• Amortisation: Similar to depreciation but applies to intangible assets like patents, licences, or software. Companies in tech or pharmaceuticals often report significant amortisation.
• Impairment Charges: These occur when an asset’s book value exceeds its fair value, such as goodwill write-downs post-acquisition. They reduce net income but don’t affect cash.
• Stock-Based Compensation: Costs related to share options or restricted stock units granted to employees, which are non-cash expenses.
• Unrealised Gains or Losses: These stem from investments, derivatives, or property revaluations, affecting reported profits without actual cash movement.
• Deferred Tax Adjustments: Timing differences in recognising revenue or expenses can create a gap between recorded tax expenses and taxes paid in cash.

Incorporating these items into your calculations ensures an accurate free cash flow estimate. For instance, the Corporate Finance Institute’s formula for free cash flow often looks like this:

FCF = Net Income + [Depreciation + Amortisation + Stock-Based Compensation + Impairment Charges ± Gains/Losses on Investments] – ΔNWC – Capex.

For FCFF, a similar approach starts with NOPAT:

Unlevered FCF = NOPAT + D&A ± Deferred Taxes ± Net Change in Working Capital – Capex.

The goal is to adjust for any expense that reduces profit without requiring a cash outlay.

How to Identify Non-Cash Adjustments in Financial Reports

Finding these adjustments is straightforward if you know where to look. The cash flow statement, particularly the operating activities section, reconciles net income to operating cash flow by listing all relevant adjustments.

For companies listed on the SGX and reporting under IFRS or Singapore Financial Reporting Standards, look for line items such as:

• “Depreciation and amortisation”
• “Impairment loss on property, plant and equipment”
• “Share-based payment expenses”
• “Fair value loss/(gain) on financial instruments”
• “Allowance for expected credit losses”
• “Unrealised foreign exchange loss/(gain)”

These adjustments are usually presented in thousands or millions of Singapore dollars.

Practical Steps for DCF Modelling

When building a DCF model in Excel, follow these steps:

1. Open the company’s annual report and locate the consolidated cash flow statement.
2. Focus on the reconciliation section, starting with “Profit before tax” or “Net profit attributable to shareholders.”
3. Identify and mark all non-cash adjustments (e.g., depreciation, amortisation, impairment charges). Add these figures back into your free cash flow calculation.

For instance, if a manufacturing company’s cash flow statement shows:

• Net profit: S$5,810,000
• Add: Depreciation of PPE: S$1,200,000
• Add: Amortisation of intangible assets: S$300,000
• Add: Impairment of machinery: S$150,000
• Less: Gain on equipment disposal: (S$50,000)

Your calculation would be:
S$5,810,000 + S$1,200,000 + S$300,000 + S$150,000 – S$50,000 = S$7,410,000

This result forms the base free cash flow figure before factoring in changes to working capital or capex.

For more detailed insights, check the financial statement notes. Companies often provide breakdowns of depreciation by asset type (e.g., buildings, machinery, vehicles) and explain significant impairments or fair value adjustments. This helps you distinguish between one-off and recurring items, which is crucial for forecasting future cash flows.

Avoiding Common Pitfalls

When handling non-cash adjustments, keep these points in mind:

• Don’t Double-Count Depreciation: Only subtract depreciation when adjusting for capex; don’t add it back twice.
• Consider All Non-D&A Items: While depreciation and amortisation are the most common, don’t overlook other adjustments like impairment charges or stock-based compensation.
• Separate Recurring from One-Off Charges: Normalise one-off expenses (e.g., a one-time impairment) and only routinely add back recurring items like depreciation and amortisation.

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Step 4: Adjust for Changes in Working Capital

After accounting for non-cash charges, the next step is to factor in cash tied up in daily operations. This adjustment helps reveal the actual cash available.

Take this scenario: when a company grows, it often extends more credit to customers, increases inventory, and manages supplier payments. These activities impact cash flow even though they don’t show up as expenses on the income statement. For instance, a Singapore retailer stocking up inventory ahead of Chinese New Year uses cash to build inventory, reducing free cash flow, even though no expense is recorded until the goods are sold.

Let’s break down net working capital and its components.

What is Net Working Capital (NWC)?

Net working capital (NWC) represents the cash tied up in a company’s operating cycle. It’s calculated as current operating assets minus current operating liabilities. This calculation focuses only on items directly linked to daily business operations.

• Current operating assets typically include trade receivables, inventories, and other operating receivables.
• Current operating liabilities consist of trade payables, accrued expenses, and other operating payables.

Some items are excluded from NWC calculations. For example, cash and cash equivalents are treated separately. Similarly, short-term debt, bank overdrafts, and the current portion of long-term loans are classified as financing items, not operating ones. For Singapore-listed companies following IFRS or Singapore Financial Reporting Standards, these classifications are detailed in the financial statements. Always check the notes to clarify any ambiguous items.

Here’s a simple example using Singapore dollar figures:

• Trade receivables: S$120,000
• Inventory: S$80,000
• Other operating receivables: S$20,000
• Trade payables: S$90,000
• Accrued expenses: S$30,000
• Other operating payables: S$10,000

The total current operating assets (S$220,000) minus current operating liabilities (S$130,000) gives a net working capital of S$90,000. This amount reflects the cash invested in the company’s operating cycle at that point.

Calculating Changes in NWC

Once you’ve defined NWC, the next step is to track its year-on-year changes. Adjusting for these changes is critical for accurate discounted cash flow (DCF) calculations.

To calculate the change in NWC, use this formula:
ΔNWC = NWC (current year) – NWC (previous year)

An increase in NWC ties up cash, while a decrease releases cash, directly impacting free cash flow.

Let’s extend the earlier example. Assume the company’s NWC in Year 1 was S$90,000. In Year 2, the figures change as follows:

• Trade receivables: S$145,000
• Inventory: S$95,000
• Other operating receivables: S$25,000
• Trade payables: S$100,000
• Accrued expenses: S$35,000
• Other operating payables: S$15,000

Year 2 current operating assets:
S$145,000 + S$95,000 + S$25,000 = S$265,000

Year 2 current operating liabilities:
S$100,000 + S$35,000 + S$15,000 = S$150,000

Year 2 NWC:
S$265,000 – S$150,000 = S$115,000

Now, calculate the change:
ΔNWC = S$115,000 – S$90,000 = S$25,000

This S$25,000 increase in NWC reduces free cash flow by the same amount. For example, if Year 2 net operating profit after tax (NOPAT) is S$500,000, depreciation and amortisation total S$80,000, and capital expenditures are S$150,000, the free cash flow would be:

FCF = S$500,000 + S$80,000 – S$25,000 – S$150,000 = S$405,000

Without the S$25,000 rise in NWC, free cash flow would have been S$430,000. This demonstrates how changes in working capital directly influence cash availability.

Drivers of NWC Changes

Understanding what drives these changes is key to analysing cash flow. Common factors include:

• Accounts receivable: A rapid increase may suggest slower collections or more lenient credit terms, consuming cash.
• Inventory: Higher inventory levels relative to sales could indicate stock build-up or weaker demand.
• Accounts payable and accrued expenses: Growth in these liabilities can provide short-term financing, boosting cash flow.

To assess whether NWC changes reflect healthy growth or potential risks, analysts often monitor ratios like days sales outstanding (DSO), days inventory outstanding (DIO), and days payables outstanding (DPO).

When building a DCF model in Excel, start by reviewing the company’s annual report. Focus on the consolidated statement of financial position, isolating operating items from financing or investing items. Compute NWC for each year and calculate the year-on-year changes.

For Singapore-listed companies, note that figures are often reported in S$ thousand or S$ million. Always ensure consistent units when calculating NWC changes.

Step 5: Subtract Capital Expenditures and Complete the FCF Calculation

Once working capital adjustments are done, the next step is subtracting capital expenditures (Capex). This final calculation reveals the cash available to investors, completing the five-step process for determining free cash flow (FCF).

Capex represents a major cash outflow, directly reducing the amount of money left for shareholders and debt holders. Unlike non-cash items that were added back earlier, Capex involves actual cash leaving the company. Accurately identifying and subtracting these investments is crucial for precise discounted cash flow (DCF) valuations.

The Role of Capex in FCF

Capital expenditures are funds spent on acquiring, upgrading, or maintaining physical assets like property, plant, and equipment (PP&E). For instance, a Singapore-based manufacturing company might invest in new machinery, factory renovations, or automated systems. In contrast, a tech company might allocate Capex to server infrastructure, office upgrades, or R&D equipment.

Since Capex reflects cash used for essential or growth-related investments, it reduces the free cash flow available to investors. You’ll typically find Capex listed in the cash flow statement under “Investing Activities”, often described as “Purchase of Property, Plant and Equipment” or a similar term. The formula for calculating Capex is:

Capex = Year 2 PP&E – Year 1 PP&E + Depreciation

This formula isolates actual capital investments by accounting for depreciation, which reduces asset value over time. For example, if a company’s PP&E grew from S$800,000 in Year 1 to S$950,000 in Year 2, with S$100,000 in depreciation for Year 2, the Capex would be:

Capex = S$950,000 – S$800,000 + S$100,000 = S$250,000

Thus, the company spent S$250,000 on new assets, factoring in depreciation. It’s also helpful to differentiate between maintenance Capex (to sustain current operations) and growth Capex (for expansion). While maintenance Capex remains steady, growth Capex often decreases as companies mature.

Complete FCF Formulas

After determining Capex, integrate it into the overall FCF calculations. The two main formulas – Unlevered Free Cash Flow (FCFF) and Free Cash Flow to Equity (FCFE) – serve different valuation purposes. FCFF measures the cash available to all investors, while FCFE focuses solely on equity shareholders.

Unlevered Free Cash Flow (FCFF):

FCFF = NOPAT + Depreciation & Amortisation +/- Deferred Income Taxes +/- Net Change in Working Capital – Capital Expenditures

Here’s the breakdown:

• NOPAT (Net Operating Profit After Tax): Operating profit after taxes.
• Depreciation & Amortisation: Added back as non-cash expenses.
• Deferred Income Taxes and Working Capital Adjustments: Account for changes in the balance sheet.
• Capital Expenditures: Subtracted to reflect long-term investments.

This formula isolates cash from core operations, independent of the company’s financing structure, and reflects cash available to all investors.

Free Cash Flow to Equity (FCFE):

FCFE = Net Income + Non-Cash Charges – Changes in Working Capital – Capital Expenditures + Net Borrowing

Alternatively:

FCFE = Cash Flow from Operations – Capital Expenditures + Net Borrowing

Unlike FCFF, FCFE starts with Net Income (which already accounts for interest and taxes) and includes net borrowing to reflect cash available to equity shareholders after debt obligations. FCFE is ideal for valuing equity, while FCFF is used to value the entire firm.

Here’s a comparison:

Example Calculation

Let’s apply these formulas to a hypothetical Singapore-based tech company with the following annual figures (in S$ millions):

• Revenue: S$100 million
• EBIT: S$25 million
• Tax Rate: 17%
• Depreciation & Amortisation: S$5 million
• Change in Working Capital: S$2 million (increase)
• Capex: S$8 million

Calculate NOPAT:

NOPAT = S$25 million × (1 – 0.17) = S$20.75 million

Calculate FCFF:

FCFF = S$20.75 million + S$5 million – S$2 million – S$8 million = S$15.75 million

This means the company has S$15.75 million available to all investors after taxes, non-cash adjustments, working capital changes, and capital investments.

If the company had net borrowing of S$3 million and an interest expense of S$1 million (with Net Income of S$19.92 million), FCFE would be:

FCFE = S$19.92 million + S$5 million – S$2 million – S$8 million + S$3 million = S$17.92 million

This shows the cash available specifically to equity holders after covering debt obligations.

Forecasting Capex in DCF Analysis

When projecting Capex for future years in a DCF model, it’s common to forecast 5 to 10 years of cash flows. Historical spending and management’s guidance are often used to estimate future Capex. A practical approach is to express Capex as a percentage of revenue or depreciation and amortisation.

When building your DCF model in Excel:

• Exclude one-time or non-recurring capital projects from future assumptions to avoid overstating cash needs.
• Cross-check Capex data from the cash flow statement with changes in fixed assets on the balance sheet to ensure accuracy.

For Singapore-listed companies following Singapore Financial Reporting Standards (SFRS), aligned with International Financial Reporting Standards (IFRS), these figures are clearly disclosed in annual reports and quarterly financial statements.

Conclusion

Understanding how to calculate free cash flow (FCF) for discounted cash flow (DCF) analysis is key to making informed trading decisions. The process involves choosing the right cash flow type, adjusting operating profit, adding back non-cash items, accounting for working capital changes, and subtracting capital expenditures (Capex). This step-by-step approach provides a solid foundation for evaluating investment opportunities.

To determine intrinsic value in SGD, project FCF over a period of five to ten years and discount these figures using the cost of equity for FCFE or the weighted average cost of capital (WACC) for FCFF. Comparing the intrinsic value to the current market price on the Singapore Exchange (SGX) can help identify whether a stock is undervalued or overvalued. By focusing on actual cash generation rather than just headline numbers, you can arrive at a more grounded valuation and strengthen your trading strategy.

For instance, you could look for SGX-listed stocks trading at least 20% below your conservative DCF estimate. Then, use technical tools like a breakout above a key moving average to time your entry. Combining FCF analysis with DCF valuation offers a structured way to support your trading decisions.

If you’re looking to refine your approach further, Collin Seow Trading Academy provides resources to help integrate fundamental valuation with systematic trading. Their courses, webinars, and materials, including the book The Systematic Trader v.2, offer practical insights into interpreting cash flows, discounting them, and aligning intrinsic values with market prices. By following a disciplined, checklist-driven process, you can remove emotional biases and make consistent, well-informed decisions in the Singapore market and beyond.

FAQs

What is the difference between FCFF and FCFE, and how do I decide which to use in my DCF analysis?

The main distinction between Free Cash Flow to the Firm (FCFF) and Free Cash Flow to Equity (FCFE) lies in their perspective. FCFF reflects the cash flow available to all investors – both equity and debt holders – after covering operating expenses and reinvestment needs. In contrast, FCFE focuses solely on the cash flow available to equity shareholders, factoring in debt-related payments like interest and principal.

If you’re valuing the entire company, especially one with a complex capital structure or significant debt, FCFF is the more suitable choice. However, if your analysis is centred on equity valuation and the company has minimal or stable debt levels, FCFE is the better option. Always pick the method that aligns with your analysis goals and the financial data at hand.

How does a change in working capital impact free cash flow, and why is it important to account for this adjustment?

Changes in working capital have a direct impact on free cash flow because they involve the cash tied up in – or released from – a company’s short-term assets and liabilities. When working capital increases, it indicates that more cash is being used to support daily operations, which reduces free cash flow. On the other hand, a decrease in working capital releases cash, boosting free cash flow.

Making adjustments for changes in working capital is essential to ensure that free cash flow calculations truly reflect the cash available to the business. This adjustment gives a more accurate view of the company’s financial health and its capacity to generate cash for purposes like investments, paying off debts, or distributing dividends.

Why do we add back non-cash expenses like depreciation and amortisation when calculating free cash flow?

Non-cash expenses like depreciation and amortisation are included back into the calculation of free cash flow because they don’t represent actual cash leaving the business. These are purely accounting figures that spread out the cost of an asset over its useful lifespan, without impacting the company’s cash reserves.

By adding these back, you get a more accurate view of the cash the business genuinely generates. This is particularly important for valuation methods like the Discounted Cash Flow (DCF) analysis, which focuses solely on real cash movements. This approach helps traders and investors make more informed decisions based on the company’s true financial health.