Levered Free Cash Flow (LFCF): Definition & Calculation

A company that has used debt financing has increased its leverage and has taken on more risk, as it has added debt and interest payments to its balance sheet and profit and loss statement, affecting its overall cash flow. Levered free cash flow (LFCF) is the term used to describe a business’ available cash after it pays all operational expenses, interest, taxes, and capital expenditures.

Calculating your company’s LFCF will give you a better idea of how sustainable and profitable your business is, and can prove its future scaling and expansion potential to investors. In this article, we will explore LFCF and its practical applications further.

Key Takeaways 

• Levered free cash flow is the money a business has left after paying all expenses, debt, and bills.
• Unlevered free cash flow is the money available before a business meets its financial obligations and pays its debts.
• LFCF can be used to reinvest in the business, pay dividends, or expand into new markets.
• Understanding your company’s LFCF is the key to attracting investors, reinvesting, or expanding your business.

Table of Contents

• What Is Levered Free Cash Flow (LFCF)?
• Levered Free Cash Flow Formula
• How To Calculate Levered Free Cash Flow With Example
• Levered FCF vs. Unlevered FCF
• Conclusion
• Frequently Asked Questions

What Is Levered Free Cash Flow (LFCF)?

Levered free cash flow (LFCF) is cash that remains in a business after paying all operating expenses, reinvestments, and financial obligations. Understanding your business’s levered FCF will provide important insight into its sustainability and profitability.

Levered Free Cash Flow Formula

You can calculate your small business’ levered FCF amount using the following levered free cash flow formula: 

LFCF = EBITDA – ΔNWC – CapEx – D

This means: Levered free cash flow = earned income before interest, taxes, depreciation, and amortization – change in net working capital – capital expenditures – mandatory debt payments

Definitions of the formula abbreviations:

• EBITDA is the earnings before interest, taxes, depreciation, and amortization that is used to determine the overall financial performance of a company.
• ΔNWC is the change in net working capital, or the difference between the company’s assets and their liabilities.
• CapEx is the business’ capital expenditures, which are any funds used to purchase, upgrade, or maintain buildings, property, machinery, technology, and other assets necessary for the business
• D is all mandatory debt payments refer to the fixed payments a company is required to make on its existing loans or bonds.

How to Calculate Levered Free Cash Flow With Example

To calculate LFCF, you will first need to know your earnings before interest, taxes, depreciation, and amortization (EBITDA), as well as the difference between a company’s current assets and their current liabilities (Net Working Capital, or ΔNWC). You will also need to know your business’ capital expenditures (CapEx), which are the funds used by a company for upgrading and maintaining machinery, technology, property, and other assets needed to do business, as well as all mandatory debt payments (D). Then you will input these figures into the following formula:

LFCF = EBITDA – ΔNWC – CapEx – D

Here is an example with financial information from a hypothetical company that earned $100,000 before interest, tax, depreciation, and amortization but then had to spend $50,000 on new equipment. They also had a net change in working capital of $12,000 and a mandatory annual debt payment of $14,000. 

	Year 1	Year 2	Year 3
EBITDA	$100,000	$200,000	$250,000
CAPEX	$50,000	$0	$0
Working Capital	$12,000	$18,000	$20,000
Mandatory Debt Payments	$14,000	$14,000	$14,000

• EBITDA: $100,000
• ΔNWC: $12,000
• CapEx: $50,000
• D: $14,000

Using the formula above, we can calculate this business’ levered FCF.

LFCF= $100,000 – $12,000 – $50,000 – $14,000

LFCF = 24,000

These numbers indicate that the hypothetical company has $24,000 available for growth, paying dividends, buying back stock, and reinvesting in the business.

In the next few years, they would not need to spend money to purchase new equipment, so their CapEx might be $0, barring any big expenses or purchases. If they were profitable, their working capital (ΔNWC) might increase to $18,000 in the first year, and $20,000 in the third, with earnings before interest, tax, depreciation, and amortization of $200, 000 in the second year, and 250,000 in the third year. If all of this were true, and they had to continue to make similar debt payments, their levered FCF would be as follows:

Year 2:

• EBITDA: $200,000
• ΔNWC: $18,000
• CapEx: $0
• D: $14,000

LFCF= $200,000 – $18,000 – $0 – $14,000

LFCF = $168,000

Year 3: 

• EBITDA: $250,000
• ΔNWC: $20,000
• CapEx: $0
• D: $14,000

Using the formula above, we can calculate this business’ levered FCF:

LFCF= $250,000 – $20,000 – $0 – $14,000

LFCF = $216,000

Sometimes, the levered FCF can be a negative number, showing that the company does not have enough money to cover its current financial obligations. Negative LFCF may indicate greater risk for investors, but it does not mean the company is failing or unstable, as long as the number does not stay negative long-term. 

Keeping an updated balance sheet and understanding your business’ finances will make these calculations easier, especially if you incorporate easy-to-use bookkeeping software like FreshBooks. Sign up to learn more about how FreshBooks can simplify your financial tracking.

Levered FCF vs. Unlevered FCF

Levered free cash flow is the amount a business has left after paying all expenses and debt, and unlevered FCF (UFCF) is the money a business has available before paying its debts. 

Calculating your business’ UFCF is important because:

•  It shows the debt-free funds available for investment back into the business, or to be paid as dividends to stockholders
• It shows a more direct comparison when you are looking at statistics on two or more companies, as all debts are taken into account

A LFCF provides a better look at each company’s ability to generate an ongoing cash flow over time, whereas a UFCF is better for determining the net present value of the business, and is used more often in valuation. Put simply, unlevered free cash flow may make your business look better on paper, but levered free cash flow will give a more accurate picture.

Both figures are important indicators of a company’s financial health and can be compared to determine the ratio of “good” to “bad” debt the company has incurred, as well as how a company will look to outside investors. 

For a more in-depth comparison, FreshBooks offers a detailed analysis of levered vs. unlevered FCF with more information about using cash flow to build and sustain your company.

Conclusion

Calculating and understanding your levered free cash flow will give you the edge you need when deciding whether to expand into new markets, take on a new project, or work on improving your business model. 

A healthy cash flow is integral to small business expansion, and you can make sure you stay on track by using helpful financial reporting software like FreshBooks, calculating your LFCF regularly, and making adjustments to your variable spending based on your findings. 

FAQs About LFCF

If you want to know more, please see the following frequently asked questions for information about the concept behind levered FCF.

What is the difference between free cash flow and levered free cash flow?

There is no difference between free cash flow and levered FCF. These terms both refer to the amount of money a company has after paying off its financial obligations, operating costs, and debt. 

Are taxes included in levered free cash flow?

No, levered free cash flow is the money a business has after paying its taxes and taking care of all other financial obligations. This cash is available for reinvestments, shareholder payments, and growth.

How do you calculate levered free cash flow yield?

To calculate a company’s LFCF yield, divide the total free cash flow by the number of shares. Then you divide the free cash flow per share by the current share price.

Free Cash Flow Yield = Free Cash Flow Per Share / Market Price Per Share

Why do we need to look at the levered free cash flow?

We need to look at the levered FCF because it is the metric that shows the company’s profitability, potential for expansion, and ability to pay returns to shareholders. It is a solvency measure and indicates how much money a business has left over after meeting all financial obligations.

Should I use levered or unlevered free cash flow?

Choosing between LFCF or UFCF depends on what information you need to know. Investors tend to watch levered FCF to determine a company’s potential profitability, while they may use UFCF to determine the net present value of a business.

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