IIM Skills Logo

Nurturing Future Leaders

Unlevered Free Cash Flow: Explained In Detail

June 29, 2025|

Lekshmi S S |

Category:Financial Modeling,Knowledge,

UFCF is the total amount available to the company before dividing it off for any financial settlements. This is of importance to the investors as it shows the growth of the company as well as how much income it has to expand its business. Let’s discuss this in detail. 

Unlevered Free Cash Flow – A Definition 

In simple words, it is the cash flow figure involved in a business. The cash flow figure of a company without taking interest payments into account, i.e., it is usually calculated before giving to interests and taxes and any other financial obligations. For capital investors, this is the amount available to them. In contrast to this, levered cash flow is the amount left with the company after all necessary bills are taken care of. 

Let’s understand deeper!

The unlevered free cash flow gives the total cash amount generated from the core and non-core business operations of the company. It is also known as ‘free cash flow to firm’ (FCFF), as this amount is available to all employees, stakeholders, vendors, interests and taxes, etc.  For the UFCF, the capital expenditures, working capital, etc. are calculated, and the final result shows the amount that will be required to maintain the company while being able to grow its assets and expand the business and ultimately generating more income and revenue. Also, the company may choose to use UFCF to calculate the discounted cash flow. This is to show the total earnings from all business operations and present investments to be in higher cash flow returns while presenting to the investors. This is to retain investors as they receive higher cash flows as the return on cost while attracting new potential investors. In contrast to this, the levered cash flow gives the amount available after all necessary tax and financial deductions where these payments are cleared using the cash flows acquired from all business operations. 

Calculating Unlevered Free Cash Flow

It is calculated by considering factors like earnings before interest, taxes, depreciation and amortization (EBITDA), working capital, and capital expenditures (CAPEX). The accounts receivable, accounts payable, and inventory are all included in the working capital. Depreciation, amortization, and similar non-cash expenses are added back to the earnings to give the final result. All the factors are populated generally in four steps:

  • Calculating the net operating profit after tax (NOPAT), where NOPAT = EBIT * (1- Tax rate) 
  • Calculating and adjusting for depreciation, amortization, and other non-cash items 
  • Subtracting the capital expenditure
  • Subtracting the final net working capital (NWC)

The EBITDA can also be calculated as:

‘EBITDA = Net Income + Interest + Taxes + Depreciation + Amortization’

Or

‘EBITDA = Operating Income + Depreciation + Amortization’

Usually, the higher EBITDA calculated for a company, the better the flow of operation in dealing with post-paying taxes and other financial debt settlements in case of an existing loan or need for a future loan. Positive and higher EBITDA results in a better UFCF score value, and can expand their business by using the additional cash flows. However, a negative cash flow or very low EBITDA value will be seen as poor service capability of the business operations and have the investors rejecting to invest in the company. 

Hence, the final formula for calculating unlevered free cash flow is as given below:

‘UFCF = EBITDA – CAPEX – Working Capital – Taxes’ 

Unlevered Free Cash Flow vs. Levered Cash Flow

The most famous question of this topic is – what is the difference between unlevered free cash flow and levered cash flow? The main difference lies in the inclusion or exclusion of financial expenses while calculating. Levered cash flow shows the amount remaining after all its loans, taxes, and other financial requirements are settled, while unlevered shows the total amount generated by the company before any of these expenditures. The amount difference between the two cash flows is also considered an important factor in business. If the difference is too vast, it can indicate a high amount of debt or overextended business. This case might lead to having a negative levered cash flow, as the total income exceeds the expenditure. The investors will not worry too much as long as this is a temporary situation and the total earnings can be brought up to a healthy number within a certain time, otherwise, you’re at risk of losing your investors. The company can also use its substantial capital investment to bring up the earnings to a higher side. Levered cash flow is important as it gives the actual number of a business’s profitability. 

On the other hand, the unlevered cash flow is the total amount earned by the company and indicates the amount available to be paid to all employees, stakeholders, equity and debt holders, etc. To sum it up, the differences between the two types of cash flows can be listed as given below:

  • Inclusion or exclusion of expenses – adding or not taking into account the basic financial expenditures while calculating.
  • Financial obligations – this usually points to the regular payments towards debts, although it can be in various other forms too. This is added back to net income while calculating levered cash flows, giving a more accurate picture of the company’s financial picture, however, this factor is not taken into consideration while calculating the unlevered cash flow. This amount is mostly used to compare different levels of debt among various companies.
  • Stakeholders and other users – In the case of levered cash flow, for expansion of business the company would need to take loans to finance this growth, in which case, the total equity available for the shareholders is reduced and there may be an increase in the debt-to-equity ratio. This can deplete a company’s financial health. This information is most commonly used by bankers and other potential investors. On the other hand, unlevered cash flow means the company can rely on its self-generated finance for any kind of expansion, although this is not recommended since spending the money without accounting for taxes and interests, can negatively impact the financial health of the company. But, this information is much useful to get an overall idea of the financial status of the company. This knowledge can also be used set annual budgets by different heads of departments and also to make sure that these funds are properly utilized by managers. This information is also commonly used by investment bankers and other potential investors.  
  • The difference in the formulas – the main difference between the two cash flows is the value of change in net working capital, usually represented mathematically by the delta (Δ) symbol. 

Recommend Read,

‘UFCF = EBITDA – CAPEX – Working Capital – Taxes’ 

And the formula for levered free cash flow (LFCF) is as given below: 

  ‘LFCF = EBITDA + Δ (NWC) – CAPEX – D’, where Δ (NWC) is the Net change in working capital, CAPEX is the capital expenditure, and D is the debt payment.  

  • Why both types of cash flow are important to track – Regardless of each cash flow’s pros and cons, they are both calculated and shown as part of the balance sheet for various purposes. The LFCF is given importance by finance professionals and major investors to see the potential of a company to be able to grow and expand its business. It is taken as a measure of sustainability, profitability, and overall growth. A company will attract more investors if it has an acceptable amount of funds left after accounting for the financial expenses. While UFCF provides an overall financial image to the investors, which can leave a good impression on them. 

As both these cash flows are important, so is the difference between the two cash flows. It is always a good idea to track both these cash flows because they change every now and then. For instance, if there is a fluctuation in sales due to any market change or trend change, or seasonal change, it can directly impact your business and finance. Tracking these cash flows also enables you to be more updated with the recent and make any necessary changes to ensure maximum profit for your company.

  • Importance of financial health – LFCF is considered to be the better of two cash flows for indicating financial health, as it shows the actual profitable amount. UFCF is important to financial health as it shows the total cash generated. This can be an important value for budgeting and forecasting models. But the main value that is even more important to financial health is the value of the difference between LFCF and UFCF. This value gives the exact amount of how much money is left available to the stakeholders and investors. This value also takes the time value of money into account. Having accurate data allows investors to make better-informed decisions about how and where to invest their funds in.  
  • Some unique disadvantages – As discussed above, each of these cash flows has its own pros and cons and it is important to know the exact difference and what to expect from both data to make more informed financial decisions. Here are some of the unique disadvantages of both cash flows: 

UFCF – manipulation of financial data can happen while calculating 

– This can influence and account for the negative consequences such as delayed capital improvements

– The changes in working capital or leverage are not taken into account while calculating which can lead to inaccuracies

LFCF – its calculation involves constantly changing values, which can make the calculation itself difficult

  • Misrepresenting debt as a negative factor when in actuality it may be a positive indicator of investment and growth of the company. 
  • Debt financing value is a risk factor.

We’ve already mentioned how the two cash flows are used in the financial models for budgeting and forecasting. So now let’s see in brief about financial modeling and how it is useful for businesses.

Professional Courses from IIM SKILLS

Financial Modeling and Their Usage

For any major decision-making process of a business or company, the main component contributing to this is the results from a financial model. These models essentially calculate the financial performance of a company within a certain time period considering all important factors such as risk and growth assumptions and interpret and present the final conclusions after comparing with past and present expected performances. Basically, they are the numerical representation of a company’s financial health for the past, present, and predicted future. Financial models can be created from scratch or new data can be added to an already existing established model.  

Financial models are used by businesses when there is a need to raise total capital, whether to sell or buy assets, how to grow the business, allocate capital and resources, budgeting, forecasting, and final valuing of the business. 

Advantages and Disadvantages of Financial Literacy –Unlevered Free Cash Flow

Financial literacy is the knowledge and know-how of the workings of finance. It is your ability to understand and utilize your financial knowledge and skills for personal financial management as well as for your business growth. This also includes skills in budgeting and investing. Not only are financially literate people less likely to be caught in financial fraud, but they can also support different life goals such as retirement plans, education expenses, marriage expenses, etc. using investment or debt responsibly, while still running a business. 

The advantage of being financially literate is having the ability to manage your personal expenses and finances much more effectively which needs experience in making good personal choices whether it is in buying or saving, insurance, budgeting, medical expenses, education expenses, retirement, real estate, and tax planning. In general, the following can be the advantages:

  • Prevent mistakes – The individual retirement account contributions cannot be taken back until retirement while different loans can have different interest rates every month. This may seem like simple financial decisions, but it can have long-term effects that impact the financial health of the individual or a business.
  • Surviving emergencies – A sudden unexpected change like a market decline or losing a job can have a negative impact on your financial well-being, but you reduce the impact by being prepared with an alternative financial plan of savings.
  • Achieving your goals – As mentioned earlier, better budgeting and planning helps you to reach your goals, be it education, health, retirement, dream house, etc.
  • Boosts Confidence – Being able to make decisions with knowledge of finance can help boost confidence, especially when it prepares you to be less anxious about any sudden change or adversity.   

The disadvantage of financial literacy lies with the individuals with little knowledge making big decisions without knowing the risks attached to the decision until it’s too late to go back and change it. The disadvantages can be at the micro-level or macro-level brought on by the inadequate amount of financial knowledge, lack of proper framework, overconfidence, and lack of proper budgeting and planning, among others. Thus, the disadvantages of financial literacy can be as follows:

  • Lack of literacy – Lacking actual complete knowledge and skills required to make good financial decisions. As we know ‘a little knowledge is a dangerous thing’.
  • Not being fully prepared – In some cases, say you’re giving more importance to your career growth or your child’s education and you’re investing and saving money for those two goals more. Then the money and assets saved for your retired life will be negligible. This may negatively impact your later life, especially as the age of retirement is being cut down in various parts of the world or as the COVID pandemic becomes an unexpected expense. Not being well-prepared can harm you in the long run.
  • Overconfidence – This can be in tandem with a lack of literacy, being confident in your little knowledge, and making wrong decisions. Some may overestimate their skills and knowledge of finance and management. The Global Financial Crisis of 2008 can be considered an example of both, as many consumers and clients did not have sufficient financial knowledge to leverage the amount of money they were supposed to gain or pay. 
  • Inequality – It is common knowledge that men are expected to take financial decisions more than women, even if she is good at saving money and only buying the essentials. Women lacking financial knowledge and being more risk-averse bring the challenge of equality.  

All in all, sometimes it is better to call in the professionals, even if it’s for taking a second opinion.  

Also Check,

Is It a Good Idea to Pursue a Career in Finance?

In one word, yes. Finance is a great career path. Because financial professionals are required everywhere in businesses no matter which industry or which region in the world. Financial professionals are required for all sorts of investment banking, banking, financial modeling, actuary, portfolio management, financial planning, securities trading, quantitative analysis, and all related tasks. Jobs in finance pay better than some of the other professions. The job provides a good working environment and a level of flexibility. These same skills can also be used in various industries. So if you’re good in math, economics, finance, etc., this would be a suitably satisfying career path for you. 

Conclusion- Unlevered Free Cash Flow

Here, we have discussed some of the common themes of unlevered free cash flow in the financial sector. We have seen the general definition, calculation, compared it with its levered free cash flow counterpart, and some of the common advantages and disadvantages of using either of them. While they are both important, it is necessary to be vigilant in calculating these cash flows and arriving at well-informed financial decisions for the overall growth of the business and company. A good financial accountant can help you with this task! 

Unlevered Free Cash Flow- Frequently Asked Questions (FAQs)

Q. Is it necessary to keep track of and compare both cash flows?

Yes, by comparing the two values of both levered cash flow and unlevered free cash flow, business owners can get a better understanding of the general good debt to bad debt ratio, the regular income and the amount of repeating expenses, how the cash flow would look in front of the investors, and the overall real financial health of the company.

Q. What does a negative unlevered free cash flow value imply?

A negative unlevered free cash flow value depicts the inability or limitations of a company in being able to generate a minimum required income to keep the business afloat. It could also mean higher expenses and less savings.

 Q. Does unlevered free cash flow & levered cash flow have any resemblance? 

Yes, both unlevered free cash flow & levered cash flow are similar in the fact that they are both considered vital on a balance sheet of the company, both values are presented to and taken into account by investment bankers and other potential investors, and both values are important in knowing income and finance of the company, and both values have its own ups and downs for everyday use.

Course Preview
Phone