What is Funds From Operations (FFO)?
As the name suggests, Funds From Operations (FFO) is the fund or cash generated from the operating activities of the business. The operating activities mean the core business activities. These cash flows exclude activities such as the sale of assets, income from investments, and so on. The term “Funds from Operations” is frequently used in financial statements of companies. FFO is crucial in measuring operational effectiveness. FFO is the cash flow that a company generates as a result of its business operations. The net inflow of cash and its equivalents as a result of a company’s operating activities is measured by funds from operations. Real estate investment trusts (REITs) are the companies that employ FFO most frequently.
Formula for Funds From Operations
Funds From Operations = (Net Income + Depreciation + Amortization + Loss on Sale of Fixed Assets) – Gains on Sale of Fixed Assets – Interest Income
- Net Income is the income from different activities after adjusting for expenses for the financial year. The net income will be specified in the Profit and Loss Statement.
- Depreciation is the annual amortisation on fixed assets to spread the cost of fixed assets over a period of time. This activity does not involve any cash flow. As a result, to calculate the real incoming cash or revenue from the REIT’s operations, depreciation and amortisation are added back to net income.
- Loss and gain on the sale of a fixed asset is a one-time activity and does not form a part of the operating activities. Hence, loss or gain from such activities must not form a part of the FFO. Since the loss and gain are included in the net income, the necessary adjustments are made.
- Many companies receive interest or return from investments in options such as mutual funds, fixed deposits, etc. These returns and interest incomes are not a part of the regular or operating income of the company. Hence, interest income adjustments are necessary.
Calculation of Funds From Operations
Let us understand the calculation of Funds From Operations with the help of an example
For the financial year 2021-22. Arun private Limited reports the following Profit and Loss Statement
|Income From Sale of Goods and Services||Rs 16,00,000|
|Gain From Sale of Furniture||Rs 2,00,000|
|Gain From Sale of Land||Rs 3,00,000|
|Interest on Fixed Deposit||Rs 50,000|
|Total Income||Rs 21,50,000|
|Expenses Incurred For Sale of Goods and services||Rs 10,50,000|
|Depreciation on Fixed Assets||Rs 2,00,000|
|Loss on Sale of Machinery||Rs 50,000|
|Net Income||Rs 8,50,000|
FFO = (Net Income + Depreciation + Amortization + Loss on Sale of Fixed Assets) – Gains on Sale of Fixed Assets – Interest Income
= (Rs 16,00,000 + Rs 2,00,000 + Rs 50,000) – Rs 2,00,000 – Rs 3,00,000 – Rs 50,000
= Rs 13,00,000
Use of FFO
Funds From Operations depicts the cash flow from the core business activities of the company. This makes it easier for financial analysts to assess how effectively a company uses its resources to generate revenue for operations. FFO also makes it possible to determine a company’s liquidity status and working capital requirements.
FFO provides an accurate picture of the operational efficiency of a REIT. Because REITs have unique characteristics that make it difficult to analyse operational efficiency using metrics of earnings. Hence, FFO is a better metric than EBITDA, net income, or cash from operations. One of the major reasons why FFO is efficient is because REITs generate significant non-cash profits and losses from the sale of fixed assets. By eliminating these aspects, you can understand the real fund flow.
Adjusted Under Funds From Operations
Adjusted Under Funds From Operations is a more accurate measure of analysing the revenue performance or potential of a REIT. It gives an indication of a REIT’s ability to earn cash or pay dividends. Adjusted Under Funds From Operations accounts for the non-recurring expenses and capital expenditures. Hence, this gives a net revenue-generating amount and the cash available for distribution. These non-recurring expenses include repair and maintenance of assets, one-time cost of improvements, and so on.
Adjusted Under Funds From Operations = Funds From Operations + Non-Recurring Expenses – Capital Expenditures
Fund Flow Vs Cash Flow From Operations
The cash flow and fund flow from operations of an organization show two distinct aspects over a time period. The cash flow will track a company’s actual cash intake and outflow (cash and cash equivalents).
|Particulars||Fund Flow||Cash Flow|
|Calculation||Change in Working Capital for a period to another||Inflow and Outflow of Cash in a Year|
|Basis of Accounting||Accrual||Cash|
|Focus||Working Capital||Cash Generation|
|Used For||Long Term Planning||Understanding Short Term Liquidity|
|Disclosure in Financial Statements||Mandatory, along with Balance Sheet and Profit and Loss Statement||Not Mandatory. Usually forms a part of investor reporting|
Frequently Asked Questions
No, Funds From Operation are not the same as EBITDA. EBITDA is the earnings before interest, taxes, depreciation and amortisation. The key difference between funds from operations and EBITDA is that EBITDA is a net profitability indicator. On the other hand, funds from operations include the effect of taxes and dividends.
Because REITs have unique characteristics that make it difficult to analyze operational efficiency. Hence, investors only rely on FFO. FFO is a better metric to measure operational efficiency than EBITDA, net income, or cash from operations. FFO makes up for cost-accounting techniques that could understate a REIT’s actual performance. Investors can use FFO to assess if money is being managed effectively. Moreover, in addition to the price-earnings ratio, many analysts and investors evaluate a REIT’s price-FFO ratio.
Fund from operations is a part of the fund flow statement. Moreover, a fund flow statement is not a mandatory statement for the companies. Hence, you might have to either prepare it or rely on the company to provide it. Most of the listed companies include the fund flow statement in their annual reports for a financial year. Many websites publish these reports on their portal for investors, analysts, and reporters. However, a cash flow statement is a mandatory statement for companies. They have to include it in the annual reports.