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Unlevered Free Cash Flow (UFCF): Guide, Formula & Examples

March 28, 2023

If you own or operate a business, cash flow is the means by which your business covers expenses. Cash flow determines how you operate, hire team members, maintain accounting procedures, and more.

Several cash flow variations are foundational to your operating income. In this post, we’ll cover basic cash flow definitions and examples, especially as they related to unlevered free cash flow (UFCF).

Here’s What We’ll Cover:

What is Free Cash Flow?

Comparing Levered and Unlevered Free Cash Flow

Unlevered Free Cash Flow Formula

Examples of Unlevered Free Cash Flow Formula

Who Looks at Unlevered Free Cash Flow?

More Accounting Resources for Businesses

What is Free Cash Flow?

By definition, free cash flow (FCF) is the amount of money available for distribution after outflows and expenses are accounted for. It’s vital to understand this definition before comparing levered vs. unlevered free cash flow.

Free cash flow shouldn’t be confused with working capital, which involves a calculation of all cash, assets, and liabilities.

What is Unlevered Free Cash Flow?

Unlevered free cash flow (UFCF) is an anticipated or theoretical figure for a business that represents the cash flow remaining before all expenses, interest payments, and capital expenditures are made. Unlevered free cash flow is visible to investors, equity holders, and debtholders in the company.

You might also hear unlevered free cash flow (UFCF) referenced as free cash flow to firm (FCFF).

What Does ‘Unlevered’ Mean?

When performing business calculations, ‘unlevered’ is a term that describes money that is available before financial obligations are met. Think of unlevered cash flow as gross cash inflow.

How is Unlevered Free Cash Flow Used?

Unlevered free cash flow (UFCF) is used at a high level to determine the enterprise value of a business. The average consumer may not ever see or need to know this amount. UFCF is helpful when a corporation wants to:

Showcase enterprise value to investors
Offer a comparison of enterprise value to other businesses
Determine net present value (NPV)
Remove the effects of debt on company value

Are There Disadvantages to Unlevered Free Cash Flow?

Yes, there are downsides to using unlevered free cash flow in business modeling.

It can be an inflated metric only designed to impress investors
It may ignore Capital Structure as part of the equation
Companies can manipulate UFCF as needed
It can lead to negative consequences (layoffs, delayed capital projects, etc.)

Comparing Levered and Unlevered Free Cash Flow

The primary difference between levered and unlevered free cash flow is the inclusion of expenses. Levered free cash flow takes a company’s financial obligations into account. This includes any interest expenses, loan payments, or costs associated with recurring business operations.

Unlevered free cash flow removes all of these debt payments from the picture. Unlevered free cash flow doesn’t imply that a business won’t meet its financial obligations, but it does illustrate cash inflows before those amounts are settled.

Unlevered Free Cash Flow Formula

The formula to calculate unlevered free cash flow (UFCF) is as follows:

UFCF = EBITDA – CAPEX – Working Capital – Taxes

To fully understand and successfully execute the unlevered free cash flow formula, it’s crucial that you have a good grasp of the following definitions.

UFCF refers to unlevered free cash flow, the final amount that you are aiming to prove.
EBITDA is the common acronym for “Earnings Before Interest, Taxes, Depreciation, and Amortization.” This is a critical piece of the puzzle that you should calculate beforehand.
CAPEX refers to capital expenditures, which can include building and equipment investments that are essential for business growth.
Working capital is the difference between assets and liabilities.
Taxes may include any federal, state, or local tax obligations.

Examples of Unlevered Free Cash Flow Formula

The UFCF formula is complex. Although each business and valuation situation is unique, an example of this calculation is below. For this situation, imagine a construction and real estate development company in the first year of business.

EBITDA = $100,000
CAPEX = $200,000 (machinery, warehouse, and building materials)
Working capital = $75,000
Taxes = $20,000
UFCF = $100,000 – $200,000 – $75,000 – $20,000

With these numbers in mind, the construction company’s UFCF is -$195,000.

The information for completing this equation may change quarterly and annually. In the example above, the company likely required a significant number of initial investments to get the business up and running. We could anticipate that in the following year, EBITDA would increase, and CAPEX would decrease, thus improving the overall amount of unlevered free cash flow.

Who Looks at Unlevered Free Cash Flow?

Unlevered free cash flow is helpful for proving enterprise value to investors, including:

Investment bankers
Equity holders
Amateur investors
Potential buyers

A simple cash flow statement may not be enough for these investors. In this instance, UFCF can be used to illustrate a more detailed future outlook for a specific company.