As a small business owner, understanding your company’s cash flow is critical to maintaining financial health. When using your cash flow statement to analyze your financial health, you can track either levered free cash flow (LFCF) or unlevered free cash flow (UFCF).
These terms could be foreign to you, but we’re here to explain the differences between unlevered vs. levered free cash flow so you can better understand how to apply them to your business.
What is free cash flow?
Before we dive deeply into the differences between levered and unlevered cash flows, it’s essential to understand what free cash flow is. Free cash flow refers to the amount of money your business has after settling debts, such as taxes, payroll, and operating expenses.
Both levered and unlevered cash flows are considered discounted cash flows (DCF), which attempt to measure how much value a business creates.
Levered and unlevered cash flow comes into play during the first portion of free cash flow projections. You can use levered or unlevered funds for the free cash flow amount in your DCF analysis. The option that you choose has a significant impact on your future valuation.
What is levered free cash flow?
Levered free cash flow projects the cash flow after removing interest expenses, capital expenditures, operational expenses, and taxes. Levered cash flows attempt to directly value the equity value of a company’s capital structure.
Essentially, levered free cash flow demonstrates a company’s cash flow after it satisfies its financial obligations and provides an accurate look at a company’s financial health and the amount of available cash. You can find levered free cash flows on the balance sheet.
What is unlevered free cash flow?
Unlevered free cash flow refers to the cash flow a business has available before satisfying its interest and other debts. In other words, it’s what you have before levered cash flow—the funding left after meeting financial obligations. Like levered cash flows, you can find unlevered cash flows on the balance sheet.
Unlevered cash flows provide a look at the company's enterprise value, which is a measure of the company’s total value. Enterprise value goes more in-depth than equity market capitalization since it considers both short-term and long-term debts and can show what a company is actually worth.
Difference between levered and unlevered free cash flow
To better understand the difference between unlevered vs. levered free cash flow, let’s look at some key differences between the two.