Funds From Operations
The term funds from operations (FFO) refers to the figure used by real estate investment trusts (REITs) to define the cash flow from their operations. Real estate companies use FFO as a measurement of operating performance. FFO is calculated by adding depreciation, amortization, and losses on sales of assets to earnings and then subtracting any gains on sales of assets and any interest income. It is sometimes quoted on a per-share basis. The FFO-per-share ratio should be used in lieu of earnings per share (EPS) when evaluating REITs and other similar investment trusts.
Definition: Funds From Operations (FFO) is a measure used by Real Estate Investment Trusts (REITs) to define their operating cash flow. It is an important metric for assessing the operational performance of real estate companies. FFO is calculated by adding depreciation, amortization, and losses on asset sales to income, then subtracting gains on asset sales and interest income. It is sometimes expressed on a per-share basis.
Origin: The concept of FFO was first introduced by the National Association of Real Estate Investment Trusts (NAREIT) in the 1990s to provide a more accurate measure of REITs' operational performance. Traditional net income metrics, which include many non-cash items like depreciation and amortization, do not accurately reflect the cash flow situation of real estate companies.
Categories and Characteristics: FFO is mainly divided into two categories: Basic FFO and Adjusted FFO. Basic FFO is calculated according to the standard formula, while Adjusted FFO considers company-specific adjustments such as non-recurring expenses or income. The characteristic of FFO is that it eliminates the impact of non-cash items, providing a more accurate reflection of the company's operating cash flow, making it suitable for evaluating the actual profitability of REITs.
Specific Cases: Case 1: A REIT company has a net income of $5 million in a fiscal year, with depreciation and amortization expenses of $2 million, asset sale losses of $0.5 million, asset sale gains of $0.3 million, and interest income of $0.2 million. The FFO calculation is as follows: FFO = 5 + 2 + 0.5 - 0.3 - 0.2 = $7 million. Case 2: Another REIT company has a net income of $1 million in a quarter, with depreciation and amortization expenses of $0.4 million, asset sale losses of $0.1 million, asset sale gains of $0.05 million, and interest income of $0.02 million. The FFO calculation is as follows: FFO = 1 + 0.4 + 0.1 - 0.05 - 0.02 = $1.43 million.
Common Questions: 1. Why is FFO more suitable than Earnings Per Share (EPS) for evaluating REITs? Because FFO excludes non-cash items like depreciation and amortization, it better reflects the company's actual cash flow situation. 2. Can FFO completely replace net income metrics? FFO is mainly used to assess the operational performance of REITs, but net income metrics still have value when conducting a comprehensive analysis of a company's financial situation.
