Looking at cash flow is a great way for investors to check the financial health of a business, while calculating levered free cash flow is one of the most effective ways to determine profitability. Find out how to calculate levered free cash flow, and more.
What is levered free cash flow?
Levered free cash flow (LFCF) measures the amount of money a company has left in its accounts after it has paid all of its short and long-term financial obligations (such as interest payments and operating expenses). Levered is just another name for debt, so if cash flows are “levered”, it means that they’re net of interest payments. In real terms, levered free cash flow is a useful way to measure a company’s ability to pay shareholders and expand its business, while it may also be a good indication of whether a company will be able to obtain additional capital through financing.
Levered free cash flow formula
Levered free cash flow is relatively simple to work out, although you will need to know a couple of key pieces of information beforehand. The levered free cash flow formula is as follows:
LFCF = EBITDA – Mandatory Debt Payments – Change in Net Working Capital – Capital Expenditures
Here’s what these terms mean in a little more detail:
EBITDA – This stands for earnings before interest, taxes, depreciation and amortization. In essence, it’s a way to determine the overall financial performance of a company.
Mandatory Debt Payments – This is everything a company owes to debtors.
Working Capital – This refers to the total amount of working capital that a company has available to it.
Capital Expenditures – These are investments in fixed assets made by a company, such as land, buildings, or equipment.
What does a negative levered free cash flow mean?
After working out your company’s levered free cash flow, you could be left with a negative amount, even if your operating cash flow is positive. This is because your company’s operating cash flow simply isn’t enough to cover all of your business’s financial obligations. If a business has a negative levered free cash flow, it’s probably a risky investment.
Having said that, a company with negative levered free cash flow could still be profitable and financially healthy. For example, if you’ve made capital investments into a physical space, such as a new warehouse, then you may end up with a negative amount. However, investing in this space could lead to greater profitability in the long-term.
Levered free cash flow vs unlevered free cash flow
When it comes to levered free cash flow vs unlevered free cash flow, the key difference is expenses. Whereas levered free cash flow is the amount of money a business has after it meets all of its financial obligations, unlevered free cash flow is the amount of cash a business has before paying off these obligations. In short, unlevered free cash flow is the gross free cash flow generated by a business.
Both metrics will appear on the balance sheet, and for many companies, the difference between levered and unlevered free cash flow is an important indicator of financial health in and of itself. This is because the difference shows how many financial obligations a company has and may indicate that the business is operating with an unhealthy amount of debt.
Ultimately, levered free cash flow is a more useful figure for investors than unlevered free cash flow, since it provides a much clearer insight into the actual profitability of a company.
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