Unlevered Free Cash Flow
Unlevered free cash flow (UFCF) is a financial metric that measures a company’s ability to generate cash flow from its operations, after accounting for its capital expenditures but before accounting for any debt or interest payments. UFCF is a key metric used in financial analysis, especially in valuing companies.
How to Calculate Unlevered Free Cash Flow
We first need to calculate a company’s operating cash flow (OCF). OCF is the cash generated by a company’s core business operations and is calculated as follows:
OCF = Operating Revenue – Operating Expenses
Operating revenue is the total revenue generated from the company’s primary business activities, while operating expenses are the costs incurred to operate the business, such as salaries, rent, and utilities. Once we have calculated OCF, we can then subtract capital expenditures (CAPEX) to arrive at UFCF.
CAPEX refers to the cash outflows that a company incurs in order to acquire or upgrade its long-term assets, such as property, plant, and equipment. CAPEX is important because it represents the amount of money that a company is investing in its future growth and is necessary to maintain and expand its operations.
Formula for calculating UFCF is as follows:
UFCF = OCF – CAPEX
- UFCF is a useful metric because it provides a measure of the amount of cash that a company has available for various purposes, such as investing in growth opportunities, paying dividends, or reducing debt. Since it is calculated before accounting for any debt or interest payments, it provides a clearer picture of a company’s financial health and its ability to generate cash flow from its core operations.
- Investors and analysts often use UFCF to compare companies within the same industry, as it can help identify which companies are generating the most cash from their operations and which are investing the most in future growth. It is also useful in evaluating the financial health of companies that are heavily reliant on debt financing, as it provides a clearer picture of their ability to generate cash flow from operations without the influence of debt or interest payments.
Levered Free Cash Flow
Levered free cash flow (LFCF) is a financial metric that measures the amount of cash generated by a business after deducting all of its operating expenses, capital expenditures, and interest payments on outstanding debt. It is a useful measure of a company’s ability to generate cash flow that can be used to pay down debt, make new investments, or distribute to shareholders.
To calculate levered free cash flow, start with the company’s earnings before interest and taxes (EBIT) and subtract taxes, capital expenditures, changes in working capital, and interest payments on outstanding debt. The resulting figure is the company’s levered free cash flow.
How to Calculate Levered Free Cash Flow
• Start with the company’s Earnings Before Interest and Taxes (EBIT).
• Subtract taxes to get the company’s Earnings After Taxes (EAT).
• EAT = EBIT – Taxes
• Subtract capital expenditures to get the company’s Operating Cash Flow (OCF).
• OCF = EAT – Capital Expenditures
• Subtract changes in working capital to get the company’s Free Cash Flow (FCF).
• FCF = OCF – Changes in Working Capital
• Add back interest expense to get the Levered Free Cash Flow (LFCF).
• LFCF = FCF + Interest Expense
Note that interest expense is added back because it represents a cash outflow that is used to service debt obligations. By adding it back, we are effectively calculating the amount of cash available to pay down debt or provide returns to equity holders after accounting for these obligations.
Levered free cash flow is an important metric for investors and analysts because it indicates how much cash a company can generate to support its debt obligations while still investing in growth opportunities. A company with strong LFCF is typically better positioned to withstand economic downturns and financial challenges.
Key differences between Unlevered Free Cash Flow and Levered Free Cash Flow
The primary difference between Levered Free Cash Flow (LFCF) and Unlevered Free Cash Flow (UFCF) is the impact of debt on the calculation.
UFCF represents the amount of cash generated by a company’s operations that is available to all investors, including both debt and equity holders, before accounting for interest payments on outstanding debt. In other words, it is calculated without considering the impact of debt financing.
LFCF, on the other hand, represents the amount of cash generated by a company’s operations that is available to equity holders after accounting for interest payments on outstanding debt. It is calculated by subtracting interest expense from UFCF.
To summarize, the key differences between LFCF and UFCF are as follows:
• Debt: LFCF considers the impact of debt financing, while UFCF does not.
• Investors: LFCF represents the amount of cash available to equity investors, while UFCF represents the amount of cash available to all investors (both debt and equity).
• Use: LFCF is used to determine the cash available to pay down debt and provide returns to equity holders, while UFCF is used to determine the cash available to all investors for potential investment or return.
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