Unlevered Free Cash Flow: Formula, Calculation, & Levered vs Unlevered Comparison

Unlevered free cash flow is one of the important financial ratios that quantify the amount of cash generated by a company based on its underlying businesses without considering the debt repayment. It reveals the amount of cash available to all the capital providers, both the debt and equity holders, and the actual performance of the company in terms of operation. Businesses that rely on professional accounting services often use metrics like UFCF to better evaluate operational performance and long-term financial health.

Since UFCF holds such great significance, we have written about the unlevered free cash flow equation, calculation, and benefits in this blog. Proper financial tracking through structured bookkeeping services also plays a major role in calculating accurate free cash flow numbers for businesses.

What is Unlevered Free Cash Flow?

Unlevered free cash flow is the amount of cash produced by a company’s business, which has been calculated by the operations of the company, taking away the operating costs, taxes, and capital expenditures. But without subtracting the interest payments made, or even using the debt financing. 

Simply put, it reflects how much money the business would bring in cases where there was no debt. 

Unlevered FCF reflects:

• Operating performance
• Operational efficiency
• Ability to generate cash that is not necessarily based on capital structure
• Real enterprise value potential
• New possibilities for cash management

It eliminates the impact of the debt and therefore enables the analysts to make comparisons between companies with varying financing structures on a more equal basis. Accurate transaction recording through structured accounts receivable services outsourcing and accounts payable services can also help businesses monitor real cash inflows and outflows when evaluating free cash flow metrics.

Importance of Unlevered Free Cash Flow

Unlevered free cash flow is an important part of financing modeling and valuation because of the following reasons: 

• Core Valuation Metric: When doing discounted cash flow analysis, the Weighted Average Cost of Capital (WACC) is used for discounting the free cash flow. This metric helps in analyzing the overall enterprise value, not just the equity value. 

• Capital Structure Neutral: Every company chooses debt and equity values for analysis. UFCF removes such choices so that one can compare firms fairly.

• Measures Operational Strength: UFCF shows how effectively a business transforms revenue into cash, which is available to the firm regardless of financing plans. Many companies rely on structured management accounts services to regularly evaluate financial performance and track such metrics.

• Applicable in Mergers and Acquisitions: Enterprise value is the focal point of buyers. UFCF is extremely applicable in mergers and acquisition deals because it provides cash available to all the investors. 

Unlevered Free Cash Flow Formula

The general unlevered free cash flow formula is: 

UFCF = EBIT × (1 − Tax Rate) + Depreciation & Amortization − Capital Expenditures − Change in Working Capital

Here, 

EBIT is earnings before interest and taxes. We begin with the interest as we are computing unlevered free cash flow. 

Depreciation and amortization are non-cash expenses. They do not decrease the actual cash but only the accounting profit, and so we add them back. 

Capital expenditures are the investment in assets that have a long duration, such as equipment, property, or technology. These are real cash outflows, and they should be deducted. 

Change in working capital can either decrease the cash value with an increase in working capital, or increase the cash value when there’s a decrease in working capital. Businesses that maintain proper tax records and filings through professional tax return services often have more reliable financial data for such calculations.

Example for unlevered free cash flow calculation:

Let’s suppose the company Tech Infra has the following: 

EBIT: $1,000,000

Tax Rate: 25%

Depreciation & Amortization: $150,000

Capital Expenditures: $200,000

Increase in Working Capital: $50,000

Now here’s the calculation: 

EBIT after tax = $1,000,000 x (1-0.25) = $750,000

With the formula: 

UFCF = 750,000 + 150,000 − 200,000 − 50,000

UFCF = $650,000

This implies that the company will produce $650,000 of unlevered free cash flow. 

Levered vs Unlevered Free Cash Flow

There’s a difference between these two terms, and it is necessary to know their characteristics.

Unlevered Free Cash Flow	Levered Free Cash Flow
Excludes interest payments	Includes interest payments
Discounted using WACC	Discounted on the cost of equity
Enterprise value is calculated using this formula.	Equity value is calculated using it.
Measures cash that is available to both debt and equity holders.	The measures cash to equity holders only.

In short, 

Unlevered = before debt payment 

Levered = after debt payments 

In case you wish to assess the total business value, unlevered free cash flow should be used. 

How is Unlevered Free Cash Flow Used in DCF Valuation?

The discounted cash flow modeling revolves around the unlevered free cash flow. 

Step 1: Forecast UFCF

Project the free cash flow that is uncredited by debt. 

Step 2: Determine the Terminal Value 

Make an estimate of the business value in the future. 

Step 3: Discount Using WACC

The discounted payback to the present value is done using the weighted average cost of capital. 

Step 4: Get the Enterprise Value 

Enterprise value = present value of the forecasted UFCF and terminal value.

To find equity value: 

Enterprise value – Net Debt = Equity Value 

Accurate financial reporting prepared through structured year end accounts & CT returns services often provides the reliable financial statements needed for valuation modeling.

Pros of Unlevered Free Cash Flow

There are a number of advantages to using UFCF in financial analysis. Let’s discuss it here: 

• Capital Structure Neutrality: It will enable the equitable comparison of highly leveraged and low-debt companies.

• Actual Operating Performance Indicator: It eliminates the effects of financing and concentrates on the operations of the business.

• Critical to Enterprise Valuation: The majority of the professional investment banking and private equity models are based on UFCF.

• More Stable than Net Income: Accounting strategies may change the net income, and cash flow may give a more accurate view of this. Businesses that maintain compliance through VAT return services also improve financial accuracy and reporting transparency.

Drawbacks of Unlevered Free Cash Flow

UFCF has some downsides that you must know about: 

• Forecasting Challenges: The assumptions involved in the projection of future revenue, margins, and CapEx might not be realized.

• Sensitive to WACC: Minor variations in the assumptions of the discount rate can have great impacts on valuation.

• Ignores Debt Burden Reality: Debt removal impact is useful in comparison; high-debt companies are actually on the verge of financial danger.

Unlevered FCF vs EBITDA 

The beginners in finances mix up UFCF and EBITDA, but please note that both of these terms are not the same. 

EBITDA	Unlevered Free Cash Flow
Profits before interest, tax, depreciation, and amortization	It is accounted for by taxes.
Does not account for CapEx.	Adjusts for working capital.
Ignores working capital changes.	Actual cash generation is represented.
	UFCF is an extended measure of cash flow.

When Should You Use Unlevered Free Cash Flow?

You are supposed to utilize unlevered free cash flow when: 

• Performing discounted cash flow valuation 
• Comparison of companies with various debt structures 
• Making a merger and acquisition analysis 
• Assessment of overall organizational profitability 
• Evaluation of long-term investment opportunities 

It particularly helps investors who are not interested in short-term earnings reports. 

Final Words 

Unlevered free cash flow is a very important measure of the true performance of a company without the influence of debt. It only concentrates on the business basics and cash-generating capacity. 

Key Points to Remember: 

• Unlevered free cash flow analyzes cash available to the debt and equity holders.
• It omits financing effects, as well as interest payments.
• It establishes an objective ground when comparing firms with varying capital structures.