Unlevered Free Cash Flow for DCF Modeling

What is Unlevered Free Cash Flow (UFCF)?

Finance professionals know Unlevered Free Cash Flow as Free Cash Flow to the Firm or FCFF for short.

It is the cash flow available to all equity holders and debtholders after all operating expenses, capital expenditures, and investments in working capital have been made.

Finance professionals use UFCF in financial modeling to determine the enterprise value of a firm. Technically, It is the cash flow that equity holders and debt holders would have access to from business operations.

How to calculate the Unlevered Free Cash Flow?

Here’s a formula for UFCF:

Unlevered FCF = EBITDA – CapEx – Working Capital – Tax Expense
Or
Unlevered FCF = Net Income + D&A – Capex – Working Capital

Let’s see the use of the formula in the DCF model in the example below.

In the given example, we have already put historical values from financial statements into the model. Let’s sum up the necessary rows to calculate the Unlevered Free Cash Flow for the given company.

Why do we use Unlevered Free Cash Flow?

We use it to remove the impact of capital structure on a company’s value. In addition, it helps to make companies more comparable. Its principal application is in valuation, where we build a discounted cash flow (DCF) model to determine the net present value (NPV) of a business. By using Unlevered Cash Flow, we determine the enterprise value, which we can easily compare to the enterprise value of another business.

The Difference Between Levered and Unlevered Free Cash Flow

The difference between the two is the inclusion of expenses. Levered cash flow is the amount of cash a business has after it has met all of its financial obligations. For example, interest, loan payments, and operating expenses. Unlevered free cash flow is the money the business has before paying those financial obligations. Companies will pay the financial obligations from levered free cash flow.

UFCF (Free Cash Flow To The Firm) is the cash flow available to all investors, both debt and equity. When performing it with a discounted cash flow – you will calculate the enterprise value.

Levered Free Cash Flow (Free Cash Flow To Equity) looks for the cash flow that is available to just equity investors. Also, we think of it as cash flow after a firm has met its financial obligations. When performing a discounted cash flow with levered free cash flow – you will calculate the equity value.

The difference between the levered and Unlevered Cash Flow shows how many financial obligations the business has. Moreover, it will show if the business is overextended or operating with a healthy amount of debt.

Conclusion

• First, the UFCF shows how much cash is available to the firm before taking financial obligations into account.
• UFCF is of interest to investors because it indicates how much cash a business has to expand.
• Finally, UFCF can be contrasted with levered free cash flow which does take into account financial obligations.

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