Funds From Operations (FFO)

Funds from operations (FFO) are the cash flows generated by a company’s activities, typically a real estate investment trust (REIT). When determine the net FFO, one will add when net profit the costs or losses not directly incurred from the activities, such as depreciation, amortization, and any losses from the selling of properties. Subtract then any gains on asset sales and interest income. This is cited periodically on a per-share basis. The FFO-per-share ratio should be utilized in lieu of earnings per share (EPS) when evaluating REITs and other similar investment trusts.

FFO is a performance metric developed by the National Association of Real Estate Investment Trusts (NAREIT), which the SEC recognizes as the traditional non-GAAP financial performance measurement for the real estate industry. FFO doesn’t include any financing-related cash flows, like interest income or expense. It also doesn’t include any gains or losses from the disposition of assets or any depreciation or amortization of fixed assets. FFO is often utilized by companies that engage in property Investment Trusts (REITs), a business that primarily operates on income-generating realty transactions.

The formula for Funds From Operations (FFO) is:

FFO = Net Income + (Depreciation expense + Amortization expense + Losses on sale of assets) – (Gains on sale of assets + Interest income)

Analysts measure the traditional form of FFO by applying amortization and depreciation to the net profit, and by subtracting any gains on asset sales. A variation on the funds from operations concept is to check it to the stock price of an organization (usually a REIT). This will be utilized in place of the price-earnings ratio, which incorporates the extra accounting factors just noted. All components of the FFO calculation are listed on a REIT’s income statement.

FFO should not be confused with the cash flow from operations of a REIT, which is recorded on the company’s cash flow statement and then calculates the net amount of cash and equivalents that come into a company from normal, continuing business activities. Investors can use the FFO to see the financial performance of a true estate company. Unlike other accounting methods, the FFO attempts to get rid of the distortion caused by traditional GAAP accounting methods.

The formula should be further modified for those forms of capital expenditure that are repetitive in nature; the FFO measure may involve depreciation related to ongoing expenditure on the upkeep of a property (such as carpet repair, interior decoration, or resurfacing of the parking lot). Often, the FFO is split by a per-share basis for securities that are publicly traded. Investors frequently utilize the FFO per-share ratio very similar to they’d utilize the EPS of the company.

Gains from the selling of an asset and interest payments are also excluded from net profits in order to determine the real cash flow from operations. Such profits do not come from the core sector. FFO shouldn’t be seen as an alternate to income as a measure of liquidity. The funds from operations concept is required, especially for the analysis of a REIT, because depreciation shouldn’t be factored into the results of operations when the underlying assets are appreciating in value, instead of depreciating; this is often a standard situation when coping with land assets. FFO is used as a more reliable measure of operating efficiency for real estate firms. Investors also use the measure to assess a real estate company’s financial results.

 

Information Sources:

  1. accountingtools.com
  2. corporatefinanceinstitute.com
  3. investopedia.com