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QuestionsCategory: Financials QuadrantFree-Cash-Flow-to-Equity Ratio
Estrella asked 12 months ago

On the “Free-Cash-Flow-to-Equity Ratio” topic, you mentioned that:
“Companies with high FCFE generate lots of cash and, as a result, tend to build a cash hoard. As the cash keep piling up, you will notice that its FCFE starts to reduce due to the rise in cash which leads to a rise in equity.” (because cash pilling up and stated as \”current asset\” in the balance sheet.)
But I was curious, isn’t it free cash flow already taken the changed in working capital into account?
Also, do you mean that FCF generated in the previous year will become the current asset (say, cash and cash equivalent) in Balance Sheet this year?

1 Answers
Victor Chng answered 12 months ago

Hi Estrella, 
 
As the company generate more free cash flow (FCF) their asset base will increase. So in the event that they generate the same amount of FCF the following year then they FCFE will decrease. 
 
For instance, the FCF generate in 2020 will increase cash & cash equivalent of the same year. This will increase the currrent asset which in return increase the equity.