What is unlevered free cash flow good for?
Unlevered free cash flow indicates how much cash a company has available before its liabilities are deducted from it. We show you here what this means exactly, how to calculate unlevered free cash flow and how to interpret it.
Unlevered free cash flow is the cash flow of a company before payments for liabilities are deducted. It therefore shows how much cash is available to the company before it meets its financial obligations.
The levered cash flow, on the other hand, indicates the cash flow of a company after all financial obligations it has to meet have been deducted. It therefore shows how much cash the company still has available after it has paid all its invoices, loan instalments, etc. The leveraged cash flow is a measure of a company's cash flow.
There are various formulas that can be used to calculate the unlevered free cash flow. As a rule, the cash flow is calculated on the basis of EBIT or EBITDA.
The formula for the unlevered free cash flow (UFCF) from EBIT (Earnings before interest & taxes) looks like this:
UFCF = EBIT - taxes + depreciation + amortisation - capital expenditures - change in non-cash working capital
Capital expenditures are investments in tangible assets (e.g. buildings, machinery or vehicles). Non-cash working capital includes investments in inventories, accounts receivable and accounts payable.
To obtain the UFCF, all non-cash items are deducted from the operating result. In the end, only the actual cash flow remains.
If you want to calculate the unlevered free cash flow from EBITDA (Earnings before interest, taxes, depreciation & amortisation), use the following formula:
UFCF = EBITDA - taxes - depreciation - amortisation - capital expenditures - change in non-cash working capital
Instead of adding depreciation and amortisation as in the first formula, they are subtracted here, as they are already included in the EBITDA value.
Another important parameter is the unlevered free cash flow yield. It indicates the amount of cash generated by the operating business of a company.
Unlevered free cash flow yield = Free cash flow to firm / Enterprise value
Free cash flow to firm is the cash flow from operating activities after deducting depreciation, taxes, working capital and investments. Since the FCFF corresponds to the UFCF from the above formulas, the formula for the yield can be simplified and written as follows:
Unlevered free cash flow yield = UFCF / Enterprise value
The enterprise value summarises the entire asset portfolio of the company. The higher the yield, the more cash the company has available for investment or to pay dividends.
A company shows the following values in its balance sheet at the end of the year:
Net profit (EBIT): £200,000
Capital expenditures: £1,000
Accounts receivable: £50,000
Accounts payable: -£40,000
Enterprise value: £500,000
We now calculate the unlevered free cash flow: UFCF = £200,000 - £20,000 - £5,000 - £3,000 - £1,000 + £3,000 - £50,000 - £40,000 = £84,000
It may be confusing here that inventories and accounts receivables are included in the calculation with the opposite sign. Therefore, a negative sign for inventories means that the company has made sales and thus received money. Therefore, this value must be added.
A positive sign in accounts receivable means that the company has made investments and thus spent money. The value must therefore be deducted. Accounts payables are the liabilities that the company has to pay and must therefore also be deducted, as it is outflowing cash.
Finally, we calculate the:
Unlevered free cash flow yield = £84,000 / £500,000 = 0.168 = 16.8%
The unlevered free cash flow yield can serve as a performance indicator for the company's operating business. The higher the yield, the more cash the company generates from its operations.