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What is an 'Unlevered Free Cash Flow - UFCF'

Unlevered free cash flow (UFCF) is a company's cash flow before taking interest payments into account. Unlevered free cash flow can be reported in a company's financial statements or calculated using financial statements by analysts for investors. Unlevered free cash flow shows how much cash is available to the firm before taking financial obligations into account.

BREAKING DOWN 'Unlevered Free Cash Flow - UFCF'

Leverage is another name for debt. When cash flows are levered, they are net of interest payments. Unlevered free cash flow, however, is the gross free cash flow generated by a firm; it is the free cash flow available to pay all stakeholders in a firm including debt holders as well as equity holders. Like levered free cash flow, unlevered free cash flow is net of capital expenditures and working capital needs – the cash needed to maintain and grow the company's asset base in order to generate revenue and earnings. Non-cash expenses such as depreciation and amortization are added back to earnings to arrive at the firm's unlevered free cash flow.

Unlevered Free Cash Flow Formula

The formula for unlevered free cash flow uses earnings before interest, taxes, depreciation and amortization (EBITDA) and capital expenditures (CAPEX), which represents the investments in buildings, machines, and equipment. It also uses working capital, which includes inventory, accounts receivable and accounts payable.

The formula is:

Unlevered Free Cash Flow = EBITDA - CAPEX - Working Capital - Taxes

Investment Considerations for Unlevered Free Cash Flow

A company that has a large amount of outstanding debt – one that is highly leveraged – is more likely to report unlevered free cash flow because it provides a rosier picture of the company's financial health. The figure shows how assets are performing in a vacuum, because it ignores the payments made for debt incurred to obtain those assets. Investors have to make sure to consider debt obligations, since highly leveraged companies are at greater risk for bankruptcy.

Companies looking to show better figures can manipulate unlevered free cash flow by laying off workers, delaying capital projects, liquidating inventory or delaying payments to suppliers. All of these actions have consequences, and investors should discern whether improvements in unlevered free cash flow are transitory or genuinely convey improvements in the underlying business of the company.

Unlevered free cash flow is before interest payments, so viewing it in a bubble ignores the capital structure of a firm. After accounting for interest payments, the levered free cash flow of a firm may actually be negative, a possible sign of negative implications down the road. Analysts should assess both unlevered and levered free cash flow over time for trends and not give either too much weight in a single year.

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