How to calculate levered free cash flow?

Levered free cash flow (LFCF) is a fundamental financial metric used by analysts and investors to evaluate the financial health and profitability of a company. It measures the cash generated by a company after meeting its interest and debt obligations, providing insights into its ability to pay off debt, invest in growth, and distribute dividends. Calculating LFCF involves a few key steps, which we will explore in this article.

How to Calculate Levered Free Cash Flow?

To calculate levered free cash flow, you need to follow these steps:

1. Determine Operating Income: Start by finding the operating income from the company’s income statement. Operating income is the revenue generated from business operations after deducting operating expenses.

2. Account for Non-Cash Expenses: Add back non-cash expenses such as depreciation and amortization to the operating income. These expenses do not involve immediate cash outflows but reduce taxable income.

3. Adjust for Changes in Working Capital: Evaluate the changes in current assets and liabilities from the balance sheet to determine the impact on cash flow. Subtract the increase in working capital or add the decrease in working capital to the result.

4. Deduct Capital Expenditures: Subtract the capital expenditures incurred during the period. Capital expenditures are the investments made to acquire or upgrade long-term assets, such as equipment or machinery.

5. Incorporate Interest Expenses: Consider the interest and debt-related expenses associated with the company’s borrowing. Deduct them from the calculated value.

6. Include Tax Benefits: Add any tax benefits resulting from interest expenses. This adjustment accounts for the tax deductions generally involved in interest payments.

The resulting value will be the levered free cash flow, representing the cash available to the company and its shareholders.

FAQs:

1. What does levered free cash flow indicate?

Levered free cash flow indicates the cash available to a company after meeting its interest and debt obligations, reflecting its ability to cover debt payments, invest in growth, and reward shareholders.

2. Why is LFCF important?

LFCF is important as it helps evaluate a company’s financial strength, its ability to generate cash, and its potential for future growth.

3. How does LFCF differ from free cash flow?

While LFCF incorporates the impact of interest and debt-related expenses, free cash flow does not account for these factors and represents the cash generated before considering debt obligations.

4. What can negative LFCF indicate?

Negative LFCF may suggest that a company is struggling to generate sufficient cash flow to cover its interest payments and debts, which could raise concerns about its financial stability.

5. How can LFCF be utilized?

LFCF can be utilized by investors to determine a company’s intrinsic value, assess its ability to repay debt, support growth initiatives, and distribute dividends.

6. What if a company has high LFCF?

A company with high LFCF has the potential to invest in growth opportunities, repay debts, increase shareholder returns, or even acquire other businesses.

7. Are there any limitations of LFCF?

LFCF calculations heavily rely on accurate financial statements and assumptions, and variations in these factors can impact the reliability of the metric.

8. Can LFCF be negative?

Yes, a company can have negative LFCF if its debt obligations and interest expenses outweigh the cash generated from its operations.

9. How can LFCF be improved?

LFCF can be improved by increasing operating income, reducing debt levels, optimizing working capital management, and minimizing capital expenditures.

10. What is the difference between levered and unlevered cash flow?

Levered cash flow considers the impact of interest and debt, whereas unlevered cash flow does not incorporate these factors. The unlevered cash flow represents the true cash generating potential of a company’s operations.

11. Can LFCF help assess dividend sustainability?

Yes, LFCF offers insights into a company’s ability to sustain dividend payments by evaluating its cash-generating capacity after debt and interest expenses.

12. How often should LFCF be calculated?

LFCF should ideally be calculated annually or on a quarterly basis to assess a company’s financial performance and changes in its cash-generating capabilities.

In conclusion, understanding how to calculate levered free cash flow provides a valuable tool for investors and analysts to evaluate a company’s financial viability. By considering interest and debt obligations, LFCF allows for more comprehensive insights into a company’s cash flow and its ability to support growth, manage debt, and provide returns to shareholders.

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