Free Cash Flow - subtract all CFI or just capex?

[DTM86]

When calculating Free Cash Flow (or FCFF or FCFE) it seems like the definition is to only subtract capital expenditures from CFO instead of all CFI. Can someone explain the rationale behind doing this and not including any other cash used by investing activities? Additionally, should proceeds from sale of assets be included in capex? Thanks.

 

[cpk123]

There are two parts to capital expenditures.
1. your Working Capital investment = which is changes in Current Assets (other than cash + Marketable securities) - Current Liabilites (other than financing related short debt items - includes Accounts Payables and Prepaids).
This would normally have also been included in your CFO calculation already.
2. Capital Expenditures on Fixed Capital - which is a part of the CFI.
So any new equipment purchases (which are outflows) as well as your equipment sold which would be an inflow. So net fixed capital expenditure would be required to be removed in both your FCFF and FCFE calculations.
FCFF is available to all the company stakeholders - before any part of interest has been paid.
So you add back interest expense after tax and any non-cash expenses to your Net Income then remove the WC Investment and the FC Investment.
FCFF = NI + NCC + Int (1-t) - FCInv - WCInv.
When you start from the CFO - remember CFO already includes the NI, NCC and the WCInv.
So FCFF = CFO + Int (1-t) - FCInv.
Now FCFE = FCFF - Int (1-t) + Net Borrowings (changes in Short term and Long term debt).

 

[e2lcfa]

I’ll try to answer your question on why u subtract only capex instead of all CFI. Capex is an ESSENTIAL CFI activity for a firm as opposed to let’s say an acquisition( A company will continue to stay in business without an acquisition. Without capex, a company cannot continue to stay in business) Every company will have capex every year.
A company needs to incur capital expenditures to conduct its business operations. If not additional capex incurred for future growth, at least maintenance capex used to maintain current operations. Only the cash flow left after taking care of working capital and capex will be available for the company to conduct other activities (dividends, share repurchase etc.)
I hope this helps!!!

 

[DTM86]

Thanks, e2lcfa, I think that helps. I understand the mechanics of the calculation and the parts, it’s more the “why” of the subtracting CFI/capex only that’s lacking.