AFFO is mostly relevant in real estate transactions. A building is bought and managed and rented. Lease payments are collected, the janitor is paid, and funds flow from the operation of this building, or set of buildings, which in the case of an AFFO, is generally in the form of a REIT, or real estate investment trust.
The AFFO element flows directly from the net after expenses of operation and taxes, as well as capital expenditures, i.e., the cost of that lit tennis court on the roof, as it relates to whatever cash is flowing back to investors.
In the case of a REIT, where multiple buildings are involved, included in the calculation of building cash flow are gains from properties that have been sold out of the portfolio for cash to some other buyer.
The key idea with AFFO: the concept, or calculation, drives entirely from cash flow, rather than accounting earnings, which might add in things like depreciation and amortization and other non-cash charges.
Related or Semi-related Video
Finance: What Does "Capital Intensive" M...26 Views
Finance a la shmoop what does capital-intensive mean? lots and lots and
lots and lots of capital yeah that's what it means starting a website, two [Two young kids setting up a website in a garage]
kids a garage and a nice home computer not capital intensive, drilling for oil
in the North Sea highly capital intensive...
well capital needed for the two kids in a garage building a search engine about
two million bucks capital needed for the oil rig well like ten billion bucks and
why does the capital intensity matter well if you can create Google that
generates a few billion dollars of free cash flow a quarter for a total capital
input of maybe a hundred million dollars ie a few rounds after the garage round [Equity investment agreement documents appear]
then investors in it make an absolute killing like if you don't dilute
yourselves and the stock goes up a lot life's good yeah hundreds or thousands
of times their original investment if you create BP British Petroleum or Royal
Dutch Shell or Chevron which also have a few billion dollars of free cash flow a [Cash flowing into fuel tanks]
quarter but it takes you ten billion dollars in capital to generate those
returns then yes you get a nice investment return but it's nothing that
you know Vikings sing songs about and it's the allure of the capital [Man typing on laptop]
unintensive businesses like building a website in Yahoo or a search engine in Google or a video streaming
site in Netflix that takes relatively small amounts of capital to start and
then produces mounds of free cash profits that has made venture
capitalists fall all over themselves hoping to find that one little garage [Person looking through binoculars at garages]
with the next great white whale yeah that's intensive...
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