FCF excludes non-cash expenses, such as depreciation and amortization, which are reported on the income statement. In contrast, levered free cash flow is used by business owners to make decisions about future capital investments, as it shows the cash available after meeting debt obligations. Generally, unlevered free cash flow provides a clearer picture of operational performance, while levered free cash flow offers a more comprehensive view of financial health by including debt obligations and interest expenses. Levered free cash flow is a better measure of an organization’s profitability because it accounts for debt obligations and expenses. Levered free cash flow (LFCF), also known as leveraged free cash flow, is an essential financial metric that describes the amount of cash a company generates from its ongoing business activities after considering all its debt payments. LFCF represents the cash available to service debts and make distributions to investors, including dividends and stock repurchases.

LFCF is the cash flow available specifically to equity shareholders after all financial obligations have been met. It is a critical measure for investors as it provides insight into a company’s profitability and its ability to return cash to shareholders. A company can exhibit a negative Levered Free Cash Flow (LFCF) even if its operating cash flow remains positive.

The third component of LFCF calculation is the change in net working capital (ΔNWC). This figure represents the variation in short-term assets and liabilities within a given time frame. A positive ΔNWC signifies an increase in net working capital, whereas a negative ΔNWC indicates a decrease.

Working capital: What is it and why is it important?

However, some significant transactions can significantly affect LFCF, such as leveraged buyouts (LBOs). In this section, we will explore how LBOs impact a company’s levered free cash flow. Many businesses prefer to show levered and unlevered free cash flows (UCFC) on the balance sheet. A major difference between the two is that LFCF accounts for deducting all the mandatory financial obligations, whereas UFCF does not deduct debts. LFCF is essential because it accounts for a company’s debt obligations, unlike unlevered free cash flow, which does not consider debt. By including interest payments and principal repayments, LFCF gives a more accurate representation of the cash available to equity shareholders.

Levered free cash flow does not always mean that a company is failing, even if it is negative. The business may have made substantial capital expenditures that are yet to begin paying off. Since debt is not free, companies must pay interest on top of their debt principal obligations. These interest payments, or “interest expense”, are reflected in the income statement and have a direct negative effect to Net Income. The calculation for levered FCF simply tries to look at what a company’s cash flows would be if they didn’t have any debt to worry about (didn’t have to take action #5).

Unlike traditional bookkeeping, which relies on periodic updates, real-time bookkeeping ensures continuous transaction recording, automated reconciliation, and real-time financial reporting. This allows business owners to make faster, data-driven decisions, reduce errors, enhance tax compliance, and stay audit-ready. By leveraging cloud-based accounting tools and AI-driven automation, businesses can optimize financial strategy, scalability, and overall efficiency, making real-time bookkeeping an essential tool for growth and long-term success.

When the amount of money generated cannot cover the company’s financial commitments then the levered cash flow is negative even when the operating cash flow is positive. As mentioned above, levered free cash flow includes expenses related to debt repayments and interest, whereas unlevered free cash flow does not include these debt obligations. Essentially, unlevered free cash flow measures the cash available to equity and debt holders before paying debt obligations, while levered free cash flow measures the cash available after debt obligations have been paid.

Levered Free Cash Flow vs Operating Cash Flow

Sandra’s areas of focus include advising real estate agents, brokers, and investors. Alongside her accounting practice, Sandra is a Money and Life Coach for women in business. The answer is that the company’s Book Income Taxes are lower in an analysis based on Levered Free Cash Flow due to the Net Interest Expense deduction, so we need to reduce the Deferred Income Taxes as well. 3) Calculate Terminal Value with P / E or Equity Value-Based Multiples – You’re considering only equity investors, so Terminal Value calculated with the Multiples Method should use an Equity Value-based multiple. 1) Use Cost of Equity for the Discount Rate, Not WACC – Since Levered FCF is available only to the equity investors, you use the Cost of Equity for the Discount Rate since it represents only the equity investors.

• When a company uses debt financing, it increases its leverage, which means it has taken on more risk because it has to make interest payments on the debt and repay the principal.
• Unlevered free cash flow is often used by banks and investors to understand how profitable a company’s operations are.
• Generally, unlevered free cash flow provides a clearer picture of operational performance, while levered free cash flow offers a more comprehensive view of financial health by including debt obligations and interest expenses.
• This functionality helps users assess the company’s ability to service debt, pay dividends, reinvest in growth, and make informed financial decisions, improving overall business planning and financial management.

Example of Calculating Levered Free Cash Flow

Calculating and understanding your levered free cash flow will give you the edge you need when deciding whether to expand into new markets, take on a new project, or work on improving your business model. LFCF can be positive or negative irrespective of a positive operative cash flow balance. However, a positive LFCF gains the investors’ trust and increases a company’s creditworthiness. The basic difference is that Levered Free Cash Flow represents the cash flow available only to the common shareholders in the company rather than all the investors. Levered free cash flow (LFCF) is the amount of cash that a company can use to pay dividends and make investments in the business. As long as the company is able to secure the necessary cash to survive until its cash flow increases, a temporary period of negative levered free cash flow is both survivable and acceptable.

There tends to be overlap in the users, stakeholders, and interested parties who rely on both unlevered and levered free cash flow. The reason for selecting one or the other often depends on the desired intention and on the level of transparency required. As a business owner, entrepreneur, or financial manager, you know that most business operations depend on cash flow.

How to Find Levered Free Cash Flow?

For this scenario, unlevered free cash flow is the before state, and levered free cash flow is the after state. In accounting, the following formula is useful for calculating unlevered free cash flow (UFCF). Unlevered free cash flow is usually only visible to financial managers and investors, rather than to the average consumer. It showcases enterprise value to debtholders with a stake in the company’s financial wellbeing.

Capital Expenditures (CapEx)Capital expenditures, levered free cash flow or CapEx, represent cash outflows made to acquire long-term assets that benefit a company beyond one accounting period. CapEx is essential in calculating LFCF because it helps determine the cash flow generated by operating activities after considering investments in long-lived assets. To calculate LFCF, it’s necessary to begin with EBITDA (earnings before interest, taxes, depreciation, and amortization). This metric illustrates a company’s operating profitability without accounting for non-cash items like depreciation and amortization, as well as tax payments. These terms both refer to the amount of money a company has after paying off its financial obligations, operating costs, and debt.

• For instance, LFCF may be useful when evaluating a company’s ability to pay dividends or repay debt, whereas UFCF is essential for analyzing its operational efficiency and profitability without the influence of financing decisions.
• LFCF is the amount retained or distributed among the stakeholders as dividends—after clearing capital expenditure and mandatory debts.
• Mandatory debt payments include both interest payments on outstanding loans and principal repayments, which are required to meet obligations to lenders.
• This article will cover what is levered free cash flow, explain the formula for levered free cash flow, and explore a real-life example of computing it.
• 1) It takes more time and effort because you have to project the company’s Cash and Debt balances, Net Interest Expense, changes in Debt principal, and more.

Forecasting unlevered free cash flow in a DCF model

Unlevered free cash flow is often used by banks and investors to understand how profitable a company’s operations are. In contrast, UFCF excludes debt payments, providing a clearer picture of a company’s operational cash flow before any financing activities are considered. Both formulas are essential for different purposes, especially when valuing a business using the discounted cash flow (DCF) method. With the above definitions in mind, unlevered free cash flow does not include expenses, while levered free cash flow factors them in. Not having positive levered free cash flow does not indicate a poor financial situation for a company.

Levered free cash flow calculation example

Levered free cash flow is a measure of a company’s ability to expand its business and to pay returns to shareholders (dividends or buybacks) via the money generated through operations. It may also be used as an indicator of a company’s ability to obtain additional capital through financing. Technically, a business’s free cash flow can’t be found on any of its financial statements. In general, the formula involves calculating what’s left after a company pays both its operating expenses and capital expenditures.