Definition
Unlevered Free Cash Flow (UFCF) is a company’s cash flow before taking interest payments into account and excluding any mandatory debt service payments. It is mainly used in valuation models and presents the cash flows from operations that are available to all capital providers. It indicates the cash available to equity shareholders if there was no debt on the company’s balance sheet.
Key Takeaways
- Unlevered Free Cash Flow (UFCF) is a company’s cash flow before taking interest payments into account. It’s a measure of the cash generated that could be used to repay investors or grow the business after all operating expenses and taxes have been paid but before any financing activities have been accounted for. Thus, it provides a pure picture of the company’s operating efficiency and cash generation.
- UFCF is often used in financial modeling, valuation, and analytical processes since it provides a cleaner measure of cash flows from operations without the impact of leverage. It’s particularly useful for comparing companies with different capital structures, as it disregards the effects of debt.
- Calculating UFCF involves subtracting operational costs, changes in net working capital, and capital expenditures from the company’s total income or revenues before interest and tax deductions (EBIT). It provides an important measure for investors, creditors, and management about the available liquidity that can potentially be distributed to investors or reinvested back into the company.
Importance
Unlevered Free Cash Flow (UFCF) is a crucial financial term as it represents the cash available to all capital holders of a company — shareholders, debt holders, and preferred equity holders — before taking into account the interest payments due on debts.
It’s a measure of a company’s financial performance and health, indicating its ability to generate cash from operations without considering capital structure.
An increasing trend of UFCF generally suggests that a company is financially robust and possesses strong growth potential.
Hence, potential investors, analysts, and creditors often scrutinize it to gauge the company’s investment attractiveness and capacity to sustain or increase dividends and repay debts.
Explanation
Unlevered Free Cash Flow (UFCF) serves as a critical tool for potential investors, stakeholders and a company’s management to evaluate the firm’s financial health and performance. UFCF reveals the amount of cash that a company can generate from its operations, after making necessary capital expenditures, but before making payments for interest and taxes.
This indicator is frequently used to assess the inherent value of a company, thus, enabling the stakeholders to make informed decisions about investing or disinvesting. Moreover, it is frequently used in valuation methods such as Discounted Cash Flow (DCF) analysis that companies use to estimate their intrinsic value.
Unlike operating cash flow or net income, UFCF isn’t influenced by the company’s leverage or debt and tax structure. This makes it an ‘apples-to-apples’ comparison, therefore, providing stakeholders with a clearer, broad, and unbiased picture of a company’s financial state and potential profitability.
This can grant businesses a more robust foundation for strategic planning, financial forecasting, and budgeting.
Examples of Unlevered Free Cash Flow (UFCF)
Amazon Inc.: In 2020, the company generated an unlevered free cash flow (UFCF) of about $81 billion USD, indicating a highly profitable business, with lots of money left over after covering its operating expenses and capital expenditures. The UFCF helps investors understand that Amazon’s operations not only cover the costs but yield a significant increase in available cash, which can be used for dividends, paying off debt, or reinvesting in the business.
Google LLC (Alphabet Inc.): As of the end of 2020, Google’s parent company Alphabet Inc. reported an impressive UFCF of approximately $8 billion USD. This gives an indication about the company’s overall financial health and its ability to pursue investment opportunities without relying on debt financing.
Tesla Inc.: In contrast to Amazon and Google, Tesla had negative UFCF in the past, such as approximately -$22 billion USD in
This signaled that Tesla’s day-to-day business operations and investments in capital expenditures were not generating enough cash, which might have been a reason for concern for investors. However, Tesla managed to improve its UFCF significantly in the following years, reporting a positive UFCF inIn all these examples, UFCF served as a key metric for investors in terms of evaluating the companies’ capacity to generate cash from their operations, minus capital expenditures, in a way that is not affected by interest payments on debt.
FAQ on Unlevered Free Cash Flow (UFCF)
What is Unlevered Free Cash Flow?
Unlevered Free Cash Flow (UFCF) is a company’s cash flow before taking interest payments into account. It represents the cash available to all stakeholders, including debt holders, equity holders, preferred equity holders, and minority shareholders, before they’re paid. It’s a good metric to understand a company’s cash flow when it has no debt.
How is Unlevered Free Cash Flow calculated?
Unlevered Free Cash Flow is calculated by starting with operating income (EBIT), adding depreciation, subtracting taxes and changes in net working capital, and subtracting capital expenditures. The formula is: UFCF = EBIT + Depreciation – Taxes – Changes in Net Working Capital – Capital Expenditures.
What does the Unlevered Free Cash Flow tell us about a company?
The Unlevered Free Cash Flow can tell us a lot about the financial health and performance of a company. A positive UFCF indicates that the company is generating more cash than it needs to maintain its current operations and can invest in growth opportunities, pay out dividends, or reduce its debt. A negative UFCF, on the other hand, might suggest that a company is not generating enough cash and might need to borrow money to finance its operations.
What is the difference between Levered and Unlevered Free Cash Flow?
Unlevered Free Cash Flow represents the total amount of cash flow available to all investors (debt and equity), whereas Levered Free Cash Flow represents the amount of cash flow available to equity investors, after all debts and related interest expenses have been paid.
How does a company increase its Unlevered Free Cash Flow?
Some of the ways to increase the Unlevered Free Cash Flow include increasing sales revenue, improving margins, reducing working capital, reducing capital expenditures, and optimizing tax management.
Related Entrepreneurship Terms
- EBIT (Earnings Before Interest and Taxes)
- Operating Cash Flow
- Capital Expenditure (CapEx)
- Enterprise Value (EV)
- Net Working Capital (NWC)
Sources for More Information
- Investopedia: A comprehensive website that provides a wealth of information on various finance and investment topics, including Unlevered Free Cash Flow (UFCF).
- Corporate Finance Institute (CFI): A professional financial training organization that offers articles, courses, and certifications on numerous financial topics, including UFCF.
- Wall Street Mojo: An educational platform geared towards investment banking, equity research, and financial analysis, often providing detailed explanations and case studies of various financial concepts including UFCF.
- The Balance: This site is a personal finance website that delivers clear, practical advice to help users understand complex financial concepts, like UFCF, and make better financial decisions.
