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Funds From Operations

Nupur Wankhede

Learn about Funds From Operations (FFO), its importance, formula, calculation, and how it differs from cash flow.

Funds From Operations (FFO) is a key financial metric used to evaluate the performance of real estate investment trusts (REITs) and similar companies. It provides a clearer picture of a company’s cash-generating ability by excluding non-cash expenses like depreciation, which may distort financial results. FFO is often used to assess a company's operating performance and is important for investors seeking to evaluate its true cash flow potential.

What Are Funds From Operations

Funds From Operations (FFO) is a measure of a company’s operating performance, primarily used by real estate investment trusts (REITs). FFO excludes non-cash items such as depreciation and amortisation, which are typically significant for real estate companies, giving a more accurate reflection of cash flow. It helps investors assess the profitability and cash-generating ability of a business.

Importance of Funds From Operations

FFO is important because it provides investors with the understanding of a company’s ability to generate cash from its operations. Unlike net income, which includes depreciation and other non-cash expenses, FFO excludes these items, making it a more accurate reflection of the company’s financial health. This metric is widely used in real estate, particularly by REITs, to evaluate their performance and dividend-paying capacity.

Funds From Operations Formula

The formula for calculating Funds From Operations is:

FFO = Net Income + Depreciation + Amortisation - Gain on Sale of Properties

This formula removes non-cash expenses and gains, providing a clearer picture of a company’s operating cash flow.

How to Calculate Funds From Operations

To calculate Funds From Operations (FFO), follow these steps:

  1. Start with Net Income: Begin with the net income reported on the income statement.

  2. Add Depreciation and Amortisation: These non-cash expenses are added back since they do not affect cash flow.

  3. Subtract Gain on Sale of Properties: If the company sold any properties during the period, subtract the gain on these sales, as this is considered a non-operating income.
     

The resulting figure is the FFO, which reflects the company’s ability to generate cash from its ongoing operations.

Funds From Operations Format

Consider the table given below:

Metric Amount (₹)

Net Income

₹500,000

Add: Depreciation

₹200,000

Add: Amortisation

₹50,000

Less: Gain on Sale of Property

₹0

FFO

₹750,000

This is a simple format showing how FFO is calculated.

Funds From Operations Example

Let’s assume a company reports the following for a given period:

  • Net Income: ₹1,000,000

  • Depreciation: ₹300,000

  • Amortisation: ₹100,000

  • Gain on Sale of Property: ₹50,000

Using the FFO formula:

FFO = ₹1,000,000 + ₹300,000 + ₹100,000 - ₹50,000 = ₹1,350,000

This means the company’s Funds From Operations (FFO) is ₹1,350,000.

Funds From Operations vs Cash Flow From Operations

Here’s a comparison between Funds From Operations (FFO) and Cash Flow From Operations (CFO):

Aspect Funds From Operations (FFO) Cash Flow From Operations (CFO)

Purpose

Used primarily by REITs and real estate companies to evaluate operational performance

Measures the total cash flow generated from a company’s core operations

Includes Non-Cash Items

Excludes depreciation, amortisation, and gain on sale of properties

Does not exclude non-cash items like depreciation or amortisation

Focus

Focuses on operating performance and cash generation

Focuses on overall cash inflows and outflows

Used By

Real estate companies and REITs

All types of companies and industries

Advantages of Using Funds From Operations

Some of the key advantages of using FFO include:

  • Accurate Cash Flow Reflection: FFO provides a clearer picture of a company’s cash-generating ability by excluding non-cash expenses.

  • Efficient Performance Assessment: It helps investors assess the company’s performance and ability to distribute dividends, particularly in the real estate sector.

  • Improved Comparisons: FFO allows for comparisons between companies, especially in industries like real estate where depreciation is significant.

Limitations of Funds From Operations

While FFO is a useful metric, it has some limitations:

  • Excludes Non-Operating Gains: FFO excludes gains from property sales, which could impact a company’s actual financial health.

  • Not a Complete Cash Measure: FFO does not account for capital expenditures or financing activities, which are important for understanding a company’s overall financial situation.

  • May Overlook Depreciation Impact: While depreciation is added back in FFO, it is a real cost for companies that need to maintain their properties.

Conclusion & Key Takeaways

Funds From Operations (FFO) is an essential metric, particularly for real estate companies and REITs, as it provides a more accurate reflection of cash flow statement by excluding non-cash items like depreciation. The key takeaways are:

  • FFO helps investors evaluate the company’s operational performance and ability to generate cash.

  • It is especially useful in real estate industries, where depreciation can significantly affect net income.

  • While useful, FFO should be considered alongside other financial metrics for a complete view of a company’s financial health.

Disclaimer

This content is for informational purposes only and the same should not be construed as investment advice. Bajaj Finserv Direct Limited shall not be liable or responsible for any investment decision that you may take based on this content.

FAQs

What is funds from operations?

Funds From Operations (FFO) is a financial metric used to measure a company’s cash-generating ability by excluding non-cash items like depreciation and amortisation.

How do you calculate funds from operations?

To calculate FFO, start with net income, add back depreciation and amortisation, and subtract any gains on the sale of properties.

What is the formula for funds from operations?

The formula is:
FFO = Net Income + Depreciation + Amortisation - Gain on Sale of Properties

Is funds from operations the same as cash flow?

No, while both metrics measure cash generation, FFO focuses on operational performance, while cash flow from operations includes all inflows and outflows, including non-cash items.

Why is funds from operations important?

FFO is important because it provides a clearer picture of a company’s ability to generate cash from its core operations, especially for REITs and real estate companies.

What is an example of funds from operations?

For example, if a company’s net income is ₹1,000,000, with depreciation of ₹300,000 and amortisation of ₹100,000, and no gain on property sales, the FFO would be ₹1,350,000.

Hi! I’m Nupur Wankhede
BSE Insitute Alumni

With a Postgraduate degree in Global Financial Markets from the Bombay Stock Exchange Institute, Nupur has over 8 years of experience in the financial markets, specializing in investments, stock market operations, and project management. She has contributed to process improvements, cross-functional initiatives & content development across investment products. She bridges investment strategy with execution, blending content insight, operational efficiency, and collaborative execution to deliver impactful outcomes.

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