Funds From Operations FFO: Definition & Calculation

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The account starts with the opening balance of profit on the credit side and ends with the closing balance of profit on the debit side. Amanda Bellucco-Chatham is an editor, writer, and fact-checker with years of experience researching personal finance topics. Specialties include general financial planning, career development, lending, retirement, tax preparation, and credit.

Funds from Operations (FFO)

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. The FFO-per-share ratio should be used in lieu of earnings per share (EPS) when evaluating REITs and other similar investment trusts. For instance, some companies measure their profitability using EBITDA or return on equity. This figure, which measures the company’s operating performance, was established by NAREIT and is now an industry standard. It takes into account depreciation, amortization, and losses on the sale of property while factoring out any interest earned along with the gains on property sales. Funds from operations (FFO) is a metric used to measure a company’s recurring operating earnings.

For a real-world example, the following screenshot is from the 10-K filing of BRE Properties. The non-controlling interest (NCI) comprises operating partnership (OP) unit holders that have not yet converted their units into common shares. Thus, the accounting treatment for the NCI ownership must abide by the consolidation method, whereby the REIT records what is fund from operation the assets (and liabilities) tied to the NCI on its balance sheet. The following pieces of information are necessary in order to calculate the funds from operations (FFO) metric. That said, the funds from operations (FFO) metric is a practical method to estimate the capacity of a REIT to maintain, or perhaps raise, its current payout of cash dividends.

What are Funds From Operations?

Therefore, the depreciation expense is added back into net income to calculate FFO. Starting with $5M net income, add $1.5M in depreciation and amortization, then subtract the $1M in gains on the sales of assets and the $250k in interest income. Since real estate companies commonly use FFO as a benchmark for performance, investors may also use FFO to evaluate a REIT equity investment before buying shares.

Although companies adjust FFO to provide investors with a more accurate reflection of their recurring income, these aren’t standardized measures. Because of that, they’re not the best for making apples-to-apples comparisons between two REITs. An investor should use FFO or ensure that both companies make the same adjustments to determine their adjusted FFO.

Funds From Operations (FFO) vs. Adjusted Funds From Operations (AFFO)

AFFO has gained traction as a more accurate estimate of a REIT’s earnings potential. To pass an Amber Partners’ review, a platform must demonstrate policies and procedures to reduce sufficiently the risk of theft and fraud, the risk of a material misstatement of NAV, and other key operational risks. It is a more realistic operating performance measure used by real estate enterprises. In addition, investors often use this statistic to assess a real estate company’s financial success.

Therefore, both terms are similar in nature since it is important to know an organization’s ability to generate cash. The main purpose of funds from operations is to assess the cash returns of a business or company. Funds from operations can be defined as the difference between the inflow of funds in the form of expenses. Funds from operations are the largest source of funds used for the repayment of loans, purchase of assets, and the payment of dividends, taxes, and others. From the following balances extracted from the books of Goods Going Ltd., calculate funds from operations for 2020 using both account format and statement format. If the profit and loss adjustment account is prepared in statement form, the statement will start with the closing balance of the profit and loss account.

Financial Management

A main reason that FFO is better for measuring performance of a REIT, compared to using net income or EPS, is that adjusts-out depreciation and amortization expenses. Real estate assets are generally appreciating assets, which means that depreciation expense may not be truly indicative economically. Adding back depreciation usually provides a more clear picture of REIT financial performance.

• Depreciation – Depreciation is an expense allocated to cover capital expenditures (the acquisition of Property Plant and Equipment PP&E, or any fixed assets).
• FFO helps normalize a REIT’s earnings by adjusting for non-cash charges and one-time expenses that don’t fully reflect its underlying earnings.
• Therefore, companies and investors use FFO to get a clear picture of the business’s operating performance.

The effectiveness of a fund administration function provided internally by a managed account platform requires competence, resources and a suitable organisational structure. Staff should have appropriate qualifications and enough experience to supervise the most complex funds on the platform. There should be sufficient staff to deal effectively with the level of work required and they shouldbe supported by IT systems able to handle the funds’ transactions. As control of the fund’s assets has been transferred to the platform, the affiliated administrator should form a separate unit and be, preferably, physically separate from the rest of the organisation.

Instead of reserving huge segments of time to study, I carved out pockets of time to learn and practise – accommodating to my full-time job. I managed to pass my Level II and Level III exams consecutively with considerably less effort and stress than when I did my level I. The calculation of AFFO for a particular REIT may not be standardized, given some variability in defining the capex number. AFFO can effectively be used to better measure a REIT’s ability to pay dividends from its net earnings.