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Unlevered free cash flow

Unlevered free cash flow

What is Unlevered Free Cash Flow?

Unlevered Free Cash Flow (UFCF) is a company's cash flow available to both capital providers (debt and equity holders).

It shows how much cash a business can generate to service its financial obligations or pay dividends after serving its financial obligations. It is also called Free Cash Flow to the Firm (FCFF).

This cash flow figure is theoretical and accounts for operating expenses, capital expenditures and investment in working capital while ignoring interest payments and debt repayments.

Unlevered free cash flow is mainly used for valuation purposes within a discounted cash flow analysis to determine a company's enterprise value.

How to calculate Unlevered Free Cash Flow

How to calculate unlevered free cash flow

There are a couple of ways to calculate unlevered free cash flow, but this is the most common way to do it:

  • EBIT (earnings before interests & taxes)

  • (-) Taxes on EBIT

  • (+) Depreciation and amortization

  • (-) Investments in working capital

  • (-) Capital expenditures

  • (=) Unlevered free cash flow


To calculate unlevered free cash flow, we start with EBIT, which is "earnings before interest & taxes". This figure is usually found on the income statement and comes before net income. EBIT already includes all expenses from business operations and excludes taxes and interest expense. From here, we can move on.


Next, we subtract taxes on EBIT. It's important to note that we have excluded interest expense.

We are factoring out capital structure to make the companies more comparable.

We exclude interest expense because unlevered free cash flow is the cash flow available to debt and equity investors. So, interest expense do not matter at this point.

Depreciation and amortization

Next, we add back depreciation and amortization. Depreciation intends to simulate wear and tear of your machinery over time.

Think of it as, for example, a truck that slowly wears down and "depreciates" over its useful period.

Amortization is the same for intangible assets, such as patents, that slowly depreciate over time. These expenses are non-cash items, so we need to add them back to derive the cash flow.

Investments in working capital

Next, we subtract investments in working capital, which equals current assets (accounts receivable and inventory) minus current liabilities (accounts payable). These adjustments are usually found in the operating cash flow sections of the cash flow statement.

If a business intends to grow in the future and increase revenues, working capital needs will also increase.

As more revenue is generated, more money will be trapped in accounts receivables, inventory needs to be built up and more payables will be due.

In other words, more capital will be locked up "working". You need more money to pay your suppliers, while the outstanding invoices will also be more significant. This is a cash outflow.

Capital expenditure

Next, we subtract capital expenditures, usually found on the cash flow statement. These are investments in new machinery to maintain or increase production in the future. We have added back depreciation and amortization, which is a non-cash expense.

Capital expenditures are the cash expense of depreciation and amortization. This is where you buy the new piece of machinery or the new truck.

This expense is not recognized in the P&L but appears on the balance sheet and then depreciates over time in the P&L. Given that capex is a cash expense, we need to subtract it here.

What's left is unlevered free cash flow

Finally, we have our unlevered free cash flow – the (theoretical) free cash flow available to debt and equity investors. Unlevered free cash flow needs to be calculated manually. It cannot be directly found on financial statements.

Why is capital structure ignored? 

When calculating unlevered free cash flow, the company's capital structure is ignored. We ignore the debt obligations because a business can vary its use of financial obligations (debt).

The level of debt varies. Some companies may not have any debt, only relying on equity and profits to fund their operations. Others might rely on debt to purchase machinery to keep their business going.

When valuating different businesses, they must be made comparable. Highly leveraged companies have more interest payments.

On the other hand, debt-free businesses would, on paper, look better than a highly leveraged one. It is impossible to compare the two companies based on levered free cash flow.

Investment Bankers and Investment Professionals prefer to look at a cash flow metric that is capital structure neutral. That way, they can assess the financial health of the business model based on profitability and cash-generating ability as opposed to different capital structures.

By excluding debt and interest payments, companies become more comparable. The Investment Professional can screen for suitable investments more easily without being skewed by different capital structures.

Levered vs. unlevered free cash flow: What's the difference?

The difference between these two cashflows is in which capital providers can access it.

Unlevered free cash flow

Unlevered free cash flow is the free cash flow available to both equity AND debt holders. Unlevered free cash flow comes before interest expense and debt repayment.

It is the free cash flow that is available to all stakeholders of the company. That's why it's also called free cash flow to the firm. These cash flows are mainly used for DCF valuations and contribute to the Enterprise Value.

Levered free cash flow

On the other hand, levered free cash flow is the free cash flow available to equity holders only after debt holders are served. Meaning it's the cash flow after interest payments and debt repayments were made. All debt obligations are met. The residual cash flow is also called cash flow to equity.

This cash flow can pay the shareholders or other investments. Levered FCF is used in an LBO, where equity investors use debt to fund a buyout. In this case, it's essential to see whether the target company has cash flows to support the interest expense and loan payments.

A company that uses a lot of debt will have a significant difference between unlevered and levered cash flow. This highly leveraged company will have to pay substantial interest expense and repay its debt over time. On the other hand, if a company is all equity financed, unlevered and levered free cash flows are identical.

When valuating a company and deriving the Enterprise Value, unlevered free cash flow is used. By ignoring capital structure, different businesses are made more comparable.

However, if an investor acquires the company with leverage (LBO), you would want to look at levered free cash flow. You want to ensure that the target company makes enough money to pay for interest expense and loan payments while paying all necessary operating expenses.

Example of unlevered free cash flow

Unlevered free cash flow sample calculation

 Here is a step-by-step example of how to calculate unlevered free cash flow:

  1. We start with EBIT (earnings before interest and tax) from the income statement

  2. Minus Taxes. Note that these tax expenses are only theoretical. We pretend that the company does not have any interest expenses. In other words, we are leaving out capital structure

  3. Plus Depreciation & amortization from the cash flow statement since it is a non-cash expense and does not affect cash flow

  4. Minus Investments in working capital from the cash flow statement. When a company grows, it usually needs more working capital. We are talking about more Accounts Receivables, Accounts Payables and Inventory. As a result, more cash will be locked in company operations

  5. Minus capital expenditures (Capex) from the cash flow statement. These are investments in new equipment, such as new machinery, to make more money. These expenses are capitalized and are not reflected in the P&L and, thus, are not included in EBIT. Capex needs to be accounted for separately

  6. The result is unlevered free cash flow

Starting with EBIT to calculate unlevered free cash flow is common in the industry. It has the advantage that you can calculate the theoretical taxes easier than beginning with EBITDA.


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