Unlevered Free Cash Flow (UFCF)Defined with Examples
What is Unlevered Free Cash Flow (UFCF)?
Unlevered Free Cash Flow refers to any company’s cash flow before any interest payments on debts are deducted.
From the name itself, unlevered means free from any form of leverage or debts.
Therefore, the UFCF removes debt from the analysis.
In financial modeling, the free cash flow is used to determine the enterprise value of a firm.
This information is important for debt holders and equity holders to know whether or not a firm’s cash flow is adequate before their financial obligations are met.
In comparison, the Levered Cash Flow is the amount of money that is left with the firm after all of their financial obligations have been paid.
The Unlevered Free Cash Flow can also be considered as the Gross Cash Cash Inflow of the firm.
In the computation of the Discounting Cash Flow analysis, the UFCF is the most preferred method of analysts.
The formula to compute for the UFCF is:
Unlevered Free Cash Flow (UFCF) = EBITDA – CAPEX – Working Capital – Taxes
Where: EBITDA – Earnings Before Interest, Taxes, Depreciation and Amortization
CAPEX – Capital Expenditures (represents the investments a company has undertaken in buildings, machines, and equipments)
Working Capital – Inventory, Accounts Receivable and Accounts Payable, or simply the difference when liabilities are subtracted from the assets
Taxes – federal, state or other tax obligations
Example and Computation
The computation of UFCF is not as simple as the formula shows.
It can be very complex.
For purposes of illustration, suppose an Energy Company wished to determine their UFCF and has provided the following details:
EBITDA – $565,000
CAPEX – $404,000
Working Capital – $67,000
Taxes – $45,000
With these information above, the UFCF is therefore $49,000 ($565,000 – $404,000 – $67,000 – $45,000).
What Does Unlevered Free Cash Flow Reveal?
The analysis of unlevered free cash flows are able to show the gross cash inflow of businesses before any of a firm’s capital structure is subtracted.
This allows for the financial report to show the availability of cash before debts are paid off.
This also shows debt and equity holders of the firm to see the availability of cash which can be paid to them.
The UFCF also excludes that which is needed for firm’s to generate revenue and earnings (working capital and capital expenditure), and not just the non-cash expenses to arrive at its value.
Most firms, especially those that are highly leveraged or have a considerable amount of debt, use the UFCF in order to show a better report of the financial health of a company.
It is also used to make companies comparable, meaning that when UFCF is the type of financial analysis used, a firm’s enterprise value is determined and can be compared to another firm’s enterprise value.
By computing for the UFCF, a firm will also be able to determine its Net Present Value (NPV) and to completely remove the possible effects a debt may have on the financials of a company.
Who Uses Unlevered Free Cash Flow
UFCF is an important financial information and is typically required by the following people:
- Debt Holders
- Equity Holders
- Investment Bankers
- Amateur Investors
The Difference Between Levered and Unlevered Free Cash Flow
The single and main difference of the Levered and Unlevered Free Cash Flow is the inclusion of financing expenses of a firm.
Levered Free Cash Flow includes these expenses while UFCF does not.
Levered Free Cash Flow computes and takes into consideration any interest expenses, loan payment and any other type of financing expenses from the firm.
On the other hand, UFCF removes these expenses and shows the amount that is available prior to the payment of financing expenses.
With the Levered and Unlevered Free Cash Flow computation, the reports will be able to show just how much debt or obligation a company has and if a firm still has a bandwidth to carry more debts.
And although having a negative Levered Free Cash flow is not ideal, the good thing about it is that this is not a permanent situation and can only be a temporary issue for investors.
Limitations of Unlevered Free Cash Flow
The single negative thing about Unlevered Free Cash Flows is its tendency to be manipulated by the management of a firm.
The working capital requirements and capital expenditure can be improved when companies lay off their workers, liquidate their inventories, delay projects, or even delay payments to their suppliers.
Investors, before making any decision must carefully assess the company and not just look at this information alone since this type of analysis does not take into consideration the capital structure of a firm.
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NYU Stern "The Free Cashflow to Firm Model" White paper. January 4, 2022
University of Washington "Why Are Investors Paying (More) Attention to Free Cash Flows?*" White paper. January 4, 2022
Stanford University "DISCOUNTED CASH FLOWS (DCF)" Page 1 - 3. January 4, 2022