Introduction

In the world of finance, the term “levered free cash flow” is commonly used to analyze a company’s financial health. It represents the cash available to a company after taking into consideration its financial obligations such as debt and interest payments. Understanding and calculating levered free cash flow can help investors determine whether a company can meet its debt obligations or not, making it an essential metric for making informed decisions. In this article, we will explore how to calculate levered free cash flow step by step.

What is Levered Free Cash Flow?

Levered free cash flow (LFCF) refers to the amount of cash a company has after paying all operational expenses, capital expenditures, and debt-related expenses such as interest payments. This metric provides an investor with insight into how much money a company has for growth or to return to shareholders either in the form of dividends or share buybacks.

Calculating Levered Free Cash Flow

To calculate levered free cash flow, follow these steps:

1. Calculate Operating Cash Flow (OCF)

Operating cash flow represents the amount of money generated from a company’s core business operations. You can find OCF on a company’s cash flow statement. Alternatively, you can compute it by using this formula:
Operating Cash Flow = Net Income + Non-Cash Expenses – Changes in Working Capital

2. Determine Capital Expenditures (CAPEX)

Capital expenditures are investments in fixed assets essential for maintaining or expanding a firm’s operations. CAPEX can be found on the investing section of the statement of cash flows or deducted from the balance sheet using the following formula:

Capital Expenditures = (Ending Value of Property, Plant & Equipment) – (Beginning Value of Property, Plant & Equipment) + Depreciation Expense

3. Calculate Unlevered Free Cash Flow (UFCF)

Subtract CAPEX from your operating cash flow to get the unlevered free cash flow:

Unlevered Free Cash Flow = Operating Cash Flow – Capital Expenditures

4. Calculate Interest Expenses

Interest expenses represent the cost of borrowed capital for a company. This information can be found in the company’s income statement or calculated using the formula:

Interest Expense = Total Debt × Interest Rate

5. Deduct Tax Savings on Interest Expense

Estimate the tax savings on interest expense by multiplying interest expense by the company’s tax rate:

Tax Saving on Interest Expense = Interest Expense × Corporate Tax Rate

6. Calculate Levered Free Cash Flow (LFCF)

Now, subtract net interest expense (interest expense – tax savings) from UFCF:

Levered Free Cash Flow = Unlevered Free Cash Flow – (Interest Expense – Tax Saving on Interest Expense)

Conclusion

Understanding and calculating levered free cash flow allows investors and analysts to evaluate a company’s ability to meet its financial obligations and generate returns for shareholders. By following these steps, one can determine if a company’s cash flow position is robust enough to finance its future growth and debt payments. In conclusion, LFCF is an essential tool in the assessment of a company’s financial health and investment potential.