What is Funds From Operations ?

2284 reads · Last updated: December 5, 2024

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 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 originated in the Real Estate Investment Trust (REIT) industry as a metric to more accurately reflect a company's operating performance. As REITs became popular in the late 20th century, FFO became an important tool for assessing the financial health of these companies.

Categories and Features

FFO is primarily used to assess the operating performance of REITs. Its key feature is the exclusion of non-cash items such as depreciation and amortization, thus providing a more accurate reflection of a company's cash flow situation. The FFO per share ratio is often used instead of earnings per share (EPS) to evaluate the profitability of REITs, as it better reflects actual cash flows.

Case Studies

Case Study 1: A well-known REIT reported strong FFO in its quarterly financial report, demonstrating robust cash flow capabilities despite net income being affected by depreciation. By using FFO, investors can better understand the company's actual financial condition. Case Study 2: Another REIT significantly increased its FFO by raising its property rental income, indicating its competitiveness and growth potential in the market.

Common Issues

Common issues investors face when using FFO include misunderstanding its difference from net income. FFO excludes depreciation and amortization, so it may be higher than net income. Additionally, FFO does not account for capital expenditures, so caution is needed when assessing long-term financial health.

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