Hey guys! I’m excited to talk about unlevered free cash flow today, something that can be a bit intimidating but is actually pretty straightforward once you get the hang of it. Unlevered free cash flow is a critical metric that businesses use to measure their financial performance, and it’s something that every CFO should be familiar with. In this article, I’m going to break down unlevered free cash flow and explain why it’s essential for assessing business performance. So, let's get started!
In simple terms, unlevered free cash flow (UFCF) is a measure of a company's cash flow after accounting for its operating expenses but excluding the effects of debt and taxes. "Unlevered" refers to the fact that it does not take into account the cost of debt, while "free cash flow" refers to the cash that remains after all expenses have been paid. This metric is important because it shows how much cash the company generates from its operations, which can be used to invest back into the business, pay dividends, or pay down debt.
To calculate unlevered free cash flow, you need to start with a company's EBITDA, which is its earnings before interest, taxes, depreciation, and amortization. Then, you subtract capital expenditures, or the amount of money the company spends on improving its assets, and changes in net working capital, which is the difference between current assets and current liabilities. The resulting number is the company's unlevered free cash flow.
Here’s the equation:
So, now that you know what unlevered free cash flow is, why is it important? Well, for starters, it’s a great indication of how much cash a company is generating from its operations. It’s also a critical component of a company's valuation because it shows how much cash is available to pay investors and creditors after accounting for all expenses. Additionally, investors and analysts use UFCF to evaluate a company's financial health and predict its future performance.
Several factors can affect a company's unlevered free cash flow. For example, if a company invests heavily in capital expenditures, such as new equipment or facilities, its UFCF will be lower. Similarly, changes in net working capital, such as changes in inventory levels or accounts payable, can impact UFCF. Changes in business strategy can also affect UFCF; for example, if a company decides to enter a new market, it may require additional investments that lower UFCF in the short-term but lead to higher cash flows in the future.
So, there you have it! Hopefully, this article helped break down unlevered free cash flow and explain why it’s an essential metric for every CFO. Understanding UFCF can help you assess a company's financial health, predict its future performance, and make informed decisions about its valuation. If you’re new to UFCF, take some time to get familiar with it and consider how it can improve your financial analyses. Trust me, it's worth it. Thanks for reading!
