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Understanding Levered and Unlevered Free Cash Flow

In the world of business, there are two types of free cash flow that have rendered organisations divided for so long. The terms levered and unlevered free cash flow (LFCF and UFCF) are used to describe two different ways of calculating a company's free cash flow. UFCF ignores the effects of debt, while LFCF includes the effects of debt.


Now, the levered vs. unlevered free cash flow debate has been going on for quite some time now, and there doesn't seem to be a clear consensus. Each side has its own advantages and disadvantages, and it really depends on the situation as to which one is better. Let's break down both delivered and unlevered free cash flow to determine which option would work best for your business.


What is Levered Free Cash Flow?


Levered free cash flow is the free cash flow of a company after accounting for its debt obligations. In other words, it's the amount of cash that a company has available to pay its creditors after it has made all of its necessary debt payments.


To calculate levered free cash flow, you simply take a company's operating cash flow and subtract its capital expenditures and interest payments. Levered free cash flow is also sometimes referred to as "after-tax operating cash flow."


What is Unlevered Free Cash Flow?


Unlevered free cash flow (UFCF) is the free cash flow of a company before accounting for its debt obligations. In other words, it's the amount of cash that a company has available to pay its creditors before it has made any of its necessary debt payments.


To calculate unlevered free cash flow, you take a company's operating cash flow and subtract its capital expenditures. Unlevered free cash flow is also sometimes referred to as "before-tax operating cash flow."


Differences between Levered and Unlevered Free Cash Flow


In finance, levered and unlevered free cash flow are two measures of a company's financial performance. Here's the difference between the two concepts:


1. Inclusion of Expenses


Levered free cash flow includes all of a company's operating and capital expenses. Unlevered free cash flow only includes operating expenses—it excludes capital expenditures.


2. Users and Stakeholders


Levered free cash flow is of more interest to creditors and stakeholders in general, as it measures a company's ability to repay its liabilities. Unlevered free cash flow is of more interest to shareholders, as it measures the amount of cash a company has available to pay dividends and reinvest in the business.


3. Timing


Levered free cash flow is realised sooner than unlevered free cash flow, as it includes the impact of debt service payments. Unlevered free cash flow is realised later, as it does not include the impact of debt service payments.


4. Calculation


Levered free cash flow is calculated as operating cash flow minus capital expenditures. Unlevered free cash flow is calculated as operating cash flow minus capital expenditures minus interest payments.


5. Taxation


Levered FCF is after-tax, while unlevered FCF is before-tax. This is because levered FCF measures the cash flow available to all the company's creditors, while unlevered FCF measures the cash flow available to the company's equity holders.


Conclusion


Overall, levered and unlevered free cash flow provide different insights into a company's financial performance. Levered free cash flow is more sensitive to changes in interest rates and financing costs, while unlevered free cash flow is more sensitive to changes in income taxes and depreciation. Ultimately, it is up to you or your finance team to decide which measure is more appropriate for the situation. There is no right or wrong answer, and it really depends on the specific situation.


If you want to make better sense of how you can track and monitor your cash flow, you should seek help from a professional accountant for your online business. The Ecommerce Accountant has earned a reputation of being the go-to partner of startups and organisations to minimise their taxes and increase their profits. Our team of experienced and passionate accounting professionals will help you manage your company's finances and make sure it's in order. Whenever you need help from an accountant for your eCommerce business, give us a call. We're more than happy to help!

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