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Levered Free Cash Flow Formula (FCF Formula Guide)

March 30, 2023

Cash flow is one of the most important aspects of business accounting, particularly if you are responsible for managing operational expenses, submitting payroll, and making investments. While you might know the importance of cash flow, do you understand the different types? Levered free cash flow is simply one cash flow measurement you should know.

Use this guide to learn the basics of the levered free cash flow formula and to start applying it to your essential business operations.

Here’s What We’ll Cover:

What is Free Cash Flow?

What is Levered Free Cash Flow?

Comparing Levered and Unlevered Free Cash Flow

Levered Free Cash Flow Formula

Who Uses Levered Free Cash Flow?

Are There Any Disadvantages to Levered Free Cash Flow?

Additional Cash Flow Resources for Businesses

What is Free Cash Flow?

To build a foundation, you should first understand the concept and definition of free cash flow (FCF). Free cash flow refers to the amount of cash that a business has left after paying its operational costs and after accounting for outflows. It is a measure of business health and viability that is important to equity holders and potential investors.

There are two types of free cash flow: unlevered free cash flow (UFCF) and levered free cash flow (LFCF).

What is Levered Free Cash Flow?

Levered free cash flow refers to the amount of cash that a company maintains after satisfying any recurring financial obligations. These obligations include both short and long-term payments, such as:

Interest payments
Operating expenses
Taxes
Capital expenditures (CAPEX)
Debt payments

Levered free cash flow (LFCF) appears on the cash flow statement of a company or small business.

What Does ‘Levered’ Mean?

In this case, the term levered simply implies a debt. In a given business model, not all debt repayment is bad. In fact, some business debt implies that an organization is making investments in the future. This is why investors leverage the LFCF amount when looking at the value of a business.

Comparing Levered and Unlevered Free Cash Flow

When comparing levered free cash flow vs unlevered free cash flow, the difference is in the addition of expenses. Levered free cash flow includes operational costs, while unlevered free cash flow provides a way to calculate without including expenses.

Both cash flows illustrate the enterprise value of a particular company, but one option (levered) may be more forthcoming when it comes to the true amount of debt.

Levered Free Cash Flow Formula

If you need to calculate the amount of cash flow after expenses, use the levered free cash flow (LFCF) formula.

LFCF = EBITDA – Change in Net Working Capital – Capital Expenditures (CAPEX) – Debt (D)

Consider the following definitions to prepare an accurate levered free cash flow calculation:

LFCF refers to levered free cash flow, the final amount that you are aiming to prove.
EBITDA stands for “Earnings Before Interest, Taxes, Depreciation, and Amortization.”
ΔNWC signifies the change in net working capital, which is a difference of assets and liabilities.
CAPEX refers to capital expenditures including investments in building, land, and equipment.
D represents any mandatory debt payment that companies make to remain in good credit standing.

Who Uses Levered Free Cash Flow?

Any individual responsible for producing free cash flow statements will likely need to use the LFCF formula at some point. Additionally, there are several “big picture” uses for levered free cash flow as it relates to business growth. These occasions can include:

When investment bankers evaluate the company for future and current cash potential
When business owners need or want to apply for loans to make further capital investments
When the board is looking to prove equity value
When potential buyers want to see the company’s long-term revenue potential

Essentially, levered free cash flow proves that a business can satisfy its obligations. When this is true, the business has more financial buffer and greater flexibility to navigate highs and lows. A stronger levered free cash flow amount implies that the organization is low-risk when it comes to borrowing money or taking on additional debt.

Are There Any Disadvantages to Levered Free Cash Flow?

Although levered free cash flow is a preferred cash metric to investors, there are a few minor disadvantages. First, the calculations include many moving pieces that may be difficult to pin down at a given time.

More importantly, however, is the misplaced idea that having business debt means less business value. As we know, some debt may be required for a business to start, grow, and flourish. When the levered free cash formula is viewed through an “all or nothing” lens concerning debt, an unnecessarily negative interpretation may occur.

Accounting professionals and financial decision-makers should maintain awareness of both advantages and disadvantages in order to make more informed cash flow choices.