Learning
Differences Between UFCF and LFCF
UFCF (Unlevered Free Cash Flow) represents the free cash flow of a company without considering financial leverage (i.e., debt is not taken into account). It excludes interest expenses and debt principal repayments. UFCF is primarily used to assess a company's operational efficiency and growth potential as it removes the impact of financial structure.
LFCF (Levered Free Cash Flow) includes the impact of a company's debt. It takes into account interest expenses and debt principal repayments, reflecting the cash flow situation of a company with actual financial leverage. LFCF shows how much cash flow is available to shareholders after accounting for debt costs.
Calculation Methods
UFCF (Unlevered Free Cash Flow)
is calculated starting from EBIT (Earnings Before Interest and Taxes), adjusting for tax effects, adding back depreciation and amortization (D&A), and then subtracting capital expenditures (CAPEX) and changes in net working capital (ΔNWC):
$ \text{UFCF} = \text{EBIT} \times (1 - \text{Tax Rate}) + \text{D\&A} - \Delta\text{NWC} - \text{CAPEX} $
LFCF (Levered Free Cash Flow)
is more complex and starts with net income, adds back interest expenses and depreciation and amortization, then subtracts capital expenditures, changes in net working capital, and debt principal repayments:
$ \text{LFCF} = \text{Net Income} + \text{Interest Expenses} + \text{D\&A} - \Delta\text{NWC} - \text{CAPEX} - \text{Debt Principal Repayments} $
Calculation of LFCF from UFCF
$ \text{LFCF} = \text{UFCF} + (\text{Interest Expense} \times \text{Tax Rate}) - \text{Debt Principal Repayments} $
This formula takes into account the following components:
- UFCF: Unlevered Free Cash Flow, which is the cash flow from operations before any debt payments are made.
- Interest Expense * Tax Rate: This represents the tax shield on interest expenses. Since interest expenses are tax-deductible, they effectively reduce the company's tax liability, providing a tax shield that increases the cash flow available to equity holders.
- Debt Principal Repayments: This is the amount of cash used to repay the principal on the company's debt. It is subtracted because it represents cash that is not available to equity holders.
By adding the tax shield from interest expenses and subtracting the debt principal repayments, you get the LFCF, which reflects the cash flow available to shareholders after accounting for the company's debt structure.
Remember, the purpose of this adjustment is to reflect the actual cash flows that equity holders would receive, taking into account the financial leverage of the company. This is important for investors who are interested in understanding the company's ability to generate cash flows that are available for distribution to them, such as dividends or share buybacks.
Application Scenarios
- UFCF is typically used to evaluate a company's operational efficiency and growth potential as it excludes the impact of financial structure, making comparisons between different companies more equitable.
- LFCF is more often used to assess shareholder value and equity valuation as it reflects the actual cash flow available to shareholders after considering debt costs.
In summary, the main difference between UFCF and LFCF lies in whether the impact of debt is considered. UFCF ignores debt and focuses more on the operational performance of the company, while LFCF includes the impact of debt, providing investors with a view of the company's cash flow situation under its actual financial structure.