What Is Debt-Adjusted Cash Flow?

Debt-adjusted cash flow (DACF) is commonly used to analyze oil companies and represents pre-tax operating cash flow (OCF) adjusted for financing expenses after taxes. Adjustments for exploration costs may also be included, as these vary from company to company depending on the accounting method used. By adding the exploration costs, the effect of the different accounting methods is removed. DACF is useful because companies finance themselves differently, with some relying more on debt.

Debt-adjusted cash flow is calculated as follows:

DACF = cash flow from operations + financing costs (after tax)

Understanding Debt-Adjusted Cash Flow (DACF)

Debt-adjusted cash flow (DACF) is often used in valuation because it adjusts for the effects of a company's capital structure. If a company uses a lot of debt, the commonly used Price/Cash Flow (P/CF) ratio may indicate the company is relatively cheaper than if its debt were taken into account. P/CF is the ratio of the company's stock price to its cash flow. If a company employs debt its cash flow may be boosted while its share price is unaffected, resulting in a lower P/CF ratio and making the company look relatively cheap.

The EV/DACF ratio removes this problem. EV, or enterprise value, reflects the amount of debt a company has, and DACF reflects the after-tax cost of that debt. The valuation ratio EV/EBITDA is used commonly to analyze companies in a variety of industries, including oil and gas. But in oil and gas, EV/DACF is also used as it adjusts for after-tax financing costs and exploration expenses, allowing for an apples-to-apples comparison.