Non-cash charges (Gatsby Co Cash Flow Statement)
Dear Instructor,
Kindly provide some clarity on the treatment of tax for the year, interest expense and depreciation expense as non-cash charges in the first example. From previous lessons, I understood that adding them to Net Income takes us back to operating profit (EBITDA). If that is the case why is the FCFF not computed as indicated below;
Operating Profit × (1−Tax Rate) - WCInv - FCInv.
Compared to;
Operating profit + Interest x (1 - tax rate) - WCInv - FCInv, especially when interest for the year was same as interest paid.
1. Are we not adding interest twice?
It is quite confusing for me. Thank you!
Hi Emmanuel,
Thank you for reaching out!
In the lessons you are referring to, we add tax, interest, and depreciation expense in order to calculate Cash Flows from Operating activities (this is a separate section in the Cash Flow Statement).
In the second example, we illustrate how to calculate Free Cash Flow to the Firm. This is a different metric and encompasses the cash flow available to the company. Hence, we need to make certain adjustments.
The best approach would be to remember the FCFF formula as it is in the second example you mention (it is widely used in the finance community).
Best,
Antoniya
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