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What does unlevered cash flow mean?
What’s essential to know?
In this article, I will break down the meaning of Unlevered Free Cash Flow so you know all there is to know about it!
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Let me explain to you what unlevered cash flow means once and for all!
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What Is Unlevered Free Cash Flow
In business, unlevered cash flow refers to a company’s cash flow before taking into consideration the company’s financial obligations.
In other words, a company’s unlevered cash flow is how much cash is available to a company before it has to make interest payments on its financial obligations.
The term “levered” refers to “leverage” which is essentially “debt”.
Unlevered cash flow is the free cash flow available to a company net of any interest payments.
The cash a company has to pay all its stakeholders, equity holders, and debt holders, is the unlevered cash flow.
Also, the levered cash flow is net of a company’s capital expenditures and working capital which is required to keep the company’s business operations.
Unlevered refers to cash flow that is funded on its own without the need for external sources of funding like loans or other sources of capital.
When a company uses external sources of funding, like a loan, we’ll say that the company is “leveraged”.
This is the case as the lenders and debt holders will have leverage over the company.
Free Cash Flow
Free cash flow refers to how much cash the company has available to it to pay its equity and debtholders.
A company that has free cash flow means that it has cash available to it to fund its business operations or pay stakeholders.
In essence, free cash flow refers to how much a company generates in cash after it has assumed its cash outflow needs and obligations.
Why Use Unlevered Free Cash Flow
Looking at a company’s unlevered free cash flow is quite important.
A company’s unlevered cash flow is the amount of cash the company has available to pay its debt and equity stakeholders.
This amount is net of a company’s interest payments and financial obligations.
Investors and financial analysts will generally look at a company’s cash flow and debt obligations to better assess the financial health of a highly leveraged company.
When a company has a lot of debt obligations on its balance sheet, it must generate enough cash flow to pay its current debt.
The more a company is leveraged, the less free cash flow will be left to fund the business or pay the owners.
For this reason, highly leveraged companies will prefer to report their unlevered cash flow as it ignores the company’s debt obligations and provides a more positive picture of the company’s financial health.
It’s important to look at a company’s unlevered cash flow but also factor in the company’s debt obligation to get a more accurate perspective of the company’s financial health.
Unlevered Free Cash Flow Formula
What is the unlevered cash flow formula?
You can calculate a company’s unlevered free cash flow by using the following formula:
UFCF = EBIDTA – CAPEX – Working Capital
- UCFC = Unlevered Free Cash Flow
- EBITDA = Earnings Before Interest, Taxes, Depreciation, And Amortization
- CAPEX = Capital Expenditures
As you can see from this formula, to calculate the “unlevered” cash flow, you will need to consider a company’s cash flow by deducting the company’s EBITDA, capital expenditures, and working capital.
Unlevered Free Cash Flow Drawbacks
The main drawback when using the unlevered cash flow is that companies can use this figure to paint a better financial picture than the company’s true financial position.
Since unlevered cash flow does not consider debt obligations, a company may delay certain projects, sell inventory, lay off employees, and take other measures to manufacture a higher unlevered cash flow.
If investors look at the unlevered cash flow without consideration of the company’s debt obligations and the measures taken by the company to generate additional cash flow, they may incorrectly perceive the company to be in a better financial health than in reality.
To better understand a company’s cash flow position, it’s important to look at both the unlevered and levered cash flow.
If a company’s levered cash flow ends up being negative, investors should pursue their due diligence to better understand what measures the company will be taking to remedy the situation to avoid financial distress in the future.
Unlevered Free Cash Flow vs Levered Free Cash Flow
What is the difference between unlevered free cash flow and levered free cash flow?
The main difference between unlevered cash flow and levered cash flow is the consideration of the company’s financing expenses.
A company’s unlevered cash flow is how much cash is available to the company before making payments on its financial obligations.
On the other hand, a levered cash flow is how much cash is available to the company after having made payments on all of its financial obligations.
The financial obligations include things like loans, interest payments, payments on debt securities, and other financing expenses.
Investors and financial analysts are generally interested in calculating the difference between the unlevered and levered cash flow to see how much cash the company must use to meet is financial obligations.
When a company has a negative levered cash flow, it means that it has more financial obligations to assume than the cash available to it, which is not a good sign if this condition lasts too long.
Unlevered Free Cash Flow Example
Let’s look at an example of unlevered free cash flow to better understand the concept.
Let’s consider a company with the following characteristics:
- EBITDA = $200,000
- CAPEX = $300,000
- Working Capital = $50,000
How much would the company’s unlevered free cash flow be?
To calculate unlevered free cash flow, we must take the company’s EBITDA ($200,000), deduct the capital expenditures ($300,000), and deduct working capital ($50,000).
We end up with a negative $150,000.
This shows that the company is not generating enough to cover its expenses.
However, let’s look at the following scenario:
- EBITDA = $400,000
- CAPEX = $150,000
- Working Capital = $50,000
In this example, the company’s unlevered free cash flow is positive $200,000.
This means that the company generates enough to cover its capital expenditures and working capital.
So there you have it folks!
What is unlevered free cash flow?
Unlevered free cash flow, as the name suggests, is how much cash that is available to company equity and debtholders after all operating expenses, capital expenditures, and working capital investments have been deducted.
The unlevered free cash flow is used to look at a company’s cash flow without the impact of the company’s capital structure.
The main use of unlevered free cash flow is to look at discounted cash flow models and calculate the net present value of a company’s cash flows.
Now that you know what is unlevered free cash flow, why it’s used, and how to calculate it, good luck with your research!
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