Levered Cash Flow vs. Unlevered Free Cash Flow: An Overview

The difference between levered and unlevered free cash flow is expenses. Levered cash flow is the amount of cash a business has after it has met its financial obligations. Unlevered free cash flow is the money the business has before paying its financial obligations. Operating expenses and interest payments are examples of financial obligations that are paid from levered free cash flow.

Both the levered and unlevered free cash flow can appear on the balance sheet. Levered cash flow is of interest to investors because it indicates how much cash a business has to expand. The difference between the levered and unlevered cash flow is also an important indicator. The difference shows how many financial obligations the business has and if the business is overextended or operating with a healthy amount of debt. It is possible for a business to have a negative levered cash flow if its expenses are more than what the company earned. This is not an ideal situation, but as long as it's a temporary issue, investors should not be too rattled.

A business that wants to expand needs cash for equipment, inventory, increased staff, and additional space. Although some businesses can afford to finance smaller expansions on their own, most businesses need to raise additional cash to make the expansion happen. Whether a business opts to bring in investors or seek financing from a bank, the health of the business is scrutinized. One of the things an investor considers is the free cash flow of the business.

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Understanding Levered And Unlevered Free Cash Flow

Levered Cash Flow

Levered free cash flow is considered the more important figure for investors to examine since it is a better indicator of the actual level of a company's profitability.

Even if a company's levered free cash flow is negative, it does not necessarily indicate that the company is failing; it may be the case that the company has made substantial capital investments that have yet to begin paying off at the level the company expects.

As long as the company is able to secure the necessary cash to survive until its cash flow increases due to increased revenues, then a temporary period of negative levered free cash flow is both survivable and acceptable.

Unlevered Free Cash Flow

Unlevered free cash flow is the gross free cash flow generated by a company. Leverage is another name for debt, and if cash flows are levered, that means they're net of interest payments. Unlevered free cash flow 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. Noncash expenses such as depreciation and amortization are added back to earnings to arrive at the firm's unlevered free cash flow.

Key Takeaways

  • Levered cash flow is the amount of cash a business has after it has met its financial obligations. 
  • Unlevered free cash flow is the money the business has before paying its financial obligations.
  • It is possible for a business to have a negative levered cash flow if its expenses are more than what the company earned.