Chartered Financial Analyst (CFA) Practice Exam Level 2

Adjusted FFO is primarily concerned with which aspect of financial performance?

1. Operational efficiency

2. Cash flow generation

3. Overall profitability

4. Tax efficiency

The correct answer is: Cash flow generation

Adjusted Funds From Operations (AFFO) is a performance metric used primarily in real estate investment trusts (REITs) and similar entities to evaluate their cash flow generation capabilities. It is derived from Funds From Operations (FFO) by making adjustments to account for recurring capital expenditures and other non-cash items that may distort the true cash flow available to shareholders or for distribution purposes. The focus on cash flow generation is crucial because it provides a clearer picture of the entity's ability to sustain operations, pay dividends, and reinvest in growth opportunities. Investors often use AFFO as a more accurate indicator of the operational performance of a real estate investment because it reflects the cash generated from properties owned, excluding the effects of non-cash accounting measures. This metric differs from other areas of financial performance such as operational efficiency, which is more about how well a company manages its resources and processes, or overall profitability, which considers total revenue and expenses to assess financial success, and tax efficiency, which relates to the effective management of tax liabilities. The primary concern of adjusted FFO remains the cash flow aspect, making it a vital tool for stakeholders assessing an organization's financial health and capacity to generate liquidity.