Levered Free Cash Flow vs. Unlevered Free Cash Flow: What’s the Difference?

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Levered Free Cash Flow vs. Unlevered Free Cash Flow: An Overview

The difference between levered and unlevered free cash flow is expenses. Levered cash flow is the amount of cash a business has after it has met its financial obligations. Unlevered free cash flow is the money the business has before paying its financial obligations. Operating expenses and interest payments are examples of financial obligations.

Key Takeaways:

• Levered cash flow is the amount of cash a business has after it has met its financial obligations. 
• Unlevered free cash flow is the money the business has before paying its financial obligations.
• It is possible for a business to have a negative levered cash flow if its expenses exceed its earnings.

Levered Free Cash Flow

The amount of money a company has left after paying all of its bills and obligations is levered free cash flow. Levered free cash flow indicates how much money a company can use to pay dividends to shareholders or to invest back in the company.

It can also help a company get financing as companies with a cushion of free cash flow are seen as low-risk borrowers. It is possible, however, that a company may also have negative levered free cash flow, which does not necessarily mean it is struggling. It may indicate a company has invested back in itself with returns that will pay off in the future.

Therefore, if a company is able to obtain the cash it needs to survive until its cash flow levels increase again, then having negative levered free cash flow for a short amount of time is ok.

Levered free cash flow is considered the more important figure for investors to examine since it is a better indicator of the actual level of a company’s profitability.

Unlevered Free Cash Flow

Unlevered free cash flow is a company’s cash flow before debt payments have been made. It is the free cash flow available to pay all the debt holders and equity holders of a firm.

Unlevered free cash flow is cash flow after capital expenditures and working capital needs have been subtracted. Both those items are needed to continue running and growing the company to generate sales and earnings.

While unlevered free cash flow can provide insight into a company’s operations, it does not provide the whole picture of a company’s financial health because it does not take into consideration debt and other obligations.

Important

Companies should generally have a healthy mix of equity financing and debt financing when running and growing their businesses.

Key Differences

Both the levered and unlevered free cash flow can appear on the balance sheet. Levered cash flow is of interest to investors because it indicates how much cash a business has to expand. The difference between the levered and unlevered free cash flow is also an important indicator.

The difference shows how many financial obligations the business has and if the business is overextended or operating with a healthy amount of debt. It is possible for a business to have a negative levered cash flow if its expenses exceed its earnings. This is not an ideal situation, but as long as it is a temporary issue, investors should not be too concerned.

A business that wants to expand needs cash for equipment, inventory, increased staff, and additional space. Although some businesses can afford to finance smaller expansions on their own, most businesses need to raise additional cash to finance the expansion.

Whether a business opts to bring in investors or seek financing from a bank, the health of the business is scrutinized. One of the things an investor considers is the free cash flow of the business.

What Is Free Cash Flow?

Free cash flow is a company’s cash level after taking into account cash outflows that are needed for operations and maintaining assets. It is the money a company can use to repay creditors, pay dividends to shareholders, or invest back into the company.

Is Too Much Free Cash Flow Bad?

Yes, excess free cash flow can be considered bad because it means a company is not utilizing its free cash for important business items, such as expanding the business or paying off creditors. While it is good to have a cushion of cash, it is also important to utilize some cash to the benefit of the business by putting it to work.

Is It Better to Use Levered or Unlevered Free Cash Flow?

Generally, when analyzing a company, it is better to use levered free cash flow because it provides a more accurate picture of a company’s financial profile. Levered free cash flow looks at cash flow after debts and obligations have been paid, which allows analysts to see how much cash a company has for different purposes, such as growing its business.

The Bottom Line

Levered and unlevered free cash flow are two ways to analyze a company’s free cash flow, each representing a different stage in a company’s financial profile. Unlevered free cash flow does not take into consideration debt payments while levered free cash flow does. As such, levered free cash flow provides a holistic picture of a company’s cash profile and the amount of money it has to pay dividends or invest back into the company.

Read the original article on Investopedia.