Unlevered free cash flow vs levered free cash flow, with a small business example

Short answer: unlevered free cash flow is the cash a business produces from trading after tax, equipment and the money tied up in customers and stock, before anything is paid to lenders. Levered free cash flow is what is left after interest and loan repayments: the cash actually available to the owners. The formulas are unlevered FCF = EBIT × (1 − tax rate) + depreciation − capital spending − increase in working capital, and levered FCF = unlevered FCF − interest after tax − loan repayments + new borrowing. A joinery business in Adelaide makes $65,000 of unlevered free cash flow in a year but only $14,500 of levered free cash flow, because $40,000 of loan repayments and the interest come first. A buyer or valuer uses the unlevered figure; an owner deciding what they can take out needs the levered one.

The two formulas

	Unlevered free cash flow	Levered free cash flow
Starts from	Operating profit (EBIT), before interest	Unlevered free cash flow
Tax	As if the business had no debt: EBIT × tax rate	Lower, because interest is tax deductible
Interest	Not taken off	Taken off
Loan repayments and new loans	Ignored	Repayments taken off, new borrowing added
Who it is for	Everyone who funds the business: lenders and owners	The owners only
Used for	Valuing the whole business (a discounted cash flow), comparing businesses funded differently	What you can pay out as dividends or drawings, and whether the debt is affordable

Unlevered free cash flow = EBIT × (1 − tax rate) + depreciation and amortisation − capital expenditure − increase in working capital

Levered free cash flow = unlevered free cash flow − interest × (1 − tax rate) − loan repayments + new borrowing

“Levered” means funded partly by debt. Unlevered free cash flow is sometimes shortened to UFCF or called free cash flow to the firm (FCFF); levered free cash flow is close to free cash flow to equity (FCFE). Some sources take off only the loan repayments and leave out new borrowing; say which version you use when you quote a figure.

A worked example: a joinery business in Adelaide

These figures are made up. Mei owns a company that makes kitchens and built-in wardrobes. Last year it bought a CNC router, and it has a $200,000 business loan at 7%, repaid at $40,000 a year over five years. Her own wage of $85,000 is in the costs, as it should be. The figures assume the 25% company tax rate and that the year’s tax is paid in the year (in practice some is paid later).

Profit and Loss for the year	$
Sales	900,000
less materials, wages and overheads	(760,000)
EBITDA	140,000
less depreciation	(20,000)
Operating profit (EBIT)	120,000
less interest on the loan (7% of 200,000)	(14,000)
Profit before tax	106,000
less company tax at 25%	(26,500)
Net profit	79,500

Unlevered free cash flow

	$
Operating profit (EBIT)	120,000
less tax on EBIT at 25%, as if there were no loan	(30,000)
= operating profit after tax (NOPAT)	90,000
plus depreciation (an expense, but no cash left)	20,000
less the CNC router and other equipment bought	(35,000)
less the increase in working capital: debtors up 14,000, stock up 2,000, suppliers owed 6,000 more	(10,000)
Unlevered free cash flow	65,000

Levered free cash flow

	$
Unlevered free cash flow	65,000
less interest	(14,000)
plus the tax the interest saves (25% of 14,000)	3,500
less loan repayments	(40,000)
plus new borrowing	0
Levered free cash flow	14,500

The same business, the same year: $65,000 before the lender, $14,500 after. The $50,500 between them is the after-tax interest ($10,500) and the repayments ($40,000).

What each figure tells Mei

• The business is healthy. $65,000 of unlevered free cash flow is 46% of its $140,000 EBITDA, after buying a new machine. A buyer valuing the business would forecast this figure, discount it, then take the loan off the result, the way the discounted cash flow guide does for a cleaning company. A third or more of that value usually comes from the terminal value, which is worked out from the final forecast year’s unlevered free cash flow.
• The loan is the squeeze, not the trading. Only $14,500 is free for Mei. If she pays herself a $30,000 dividend on the strength of $79,500 of net profit, the bank balance falls by about $15,500 over the year.
• Refinancing changes only the levered figure. Spread the loan over ten years instead of five and repayments drop to about $20,000: levered free cash flow rises to $34,500, and unlevered free cash flow stays at $65,000. The business did not get better; the timing of paying the lender changed.

Three routes to the same unlevered figure

Start from	Calculation	Result
EBIT	120,000 − 30,000 + 20,000 − 35,000 − 10,000	65,000
EBITDA	140,000 − 30,000 tax on EBIT − 35,000 − 10,000	65,000
Net profit	79,500 + 20,000 + 10,500 interest after tax − 35,000 − 10,000	65,000

The net profit route is the one to use from Xero, because net profit already has the real tax and interest in it. The EBITDA calculator works out EBITDA and EBIT from a Profit and Loss if you need them first.

How to get the figures from Xero

1. Net profit, interest and depreciation. Run Accounting › Reports › Profit and Loss for the financial year. Interest and depreciation are usually their own expense lines.
2. Operating cash flow. Run the Statement of Cash Flows for the same dates. “Net Cash Flows from Operating Activities” already includes the change in debtors, stock and suppliers, and it is after tax and, usually, after interest paid (check where your interest account is mapped). Mei’s is 79,500 + 20,000 − 10,000 = $89,500. The Xero statement of cash flows guide explains each line.
3. Equipment bought. The investing section of the same report, or the movement on your fixed asset accounts on the Balance Sheet.
4. Loan repayments and new loans. The financing section, or the movement on the loan account on the Balance Sheet.
5. Put it together. Operating cash flow − equipment = free cash flow as most owners use it ($54,500 for Mei). Add the after-tax interest back for unlevered ($54,500 + 10,500 = $65,000); take the repayments off for levered ($54,500 − 40,000 = $14,500). The free cash flow calculator does the middle step from either operating cash flow or net profit.

Menu names move between Xero releases and regions, so search Xero Central for the report name if your screen differs.

Common mistakes

• Using unlevered free cash flow to set dividends or drawings. It is before the lender is paid. What you can take out comes from the levered figure, less a buffer.
• Quoting unlevered free cash flow to a lender as if it were their figure. Lenders size loans on CFADS, which usually takes off only maintenance spending and the tax actually paid. Work out theirs separately.
• Taking interest off twice. If you start from net profit, interest is already deducted: add it back (after tax) for the unlevered figure. If you start from EBIT, it was never taken off.
• Using the real tax bill in unlevered free cash flow. Unlevered tax is the tax on EBIT, as if there were no loan. The real bill is lower because interest is deductible; that saving belongs in the levered figure.
• Forgetting working capital. A growing business ties up more in debtors and stock each year. Leaving it out makes both figures look better than the bank balance.
• Counting depreciation and the purchase. Add depreciation back and take off the cash spent on equipment. Leaving depreciation in charges for the equipment twice.
• Valuing with levered free cash flow at a business-wide rate. Levered free cash flow belongs to the owners alone, so it is discounted at the return owners want and gives the value of the shares directly. Unlevered free cash flow gives the value of the whole business, and the debt comes off afterwards. Mixing the two counts the loan twice or not at all.

Common questions

What is unlevered free cash flow? It is the cash a business produces after tax, spending on equipment and the change in working capital, before any payments to lenders. It shows what the business generates however it is funded, so it is the figure used to value a whole business and to compare businesses with different amounts of debt.

How do you calculate unlevered free cash flow? Unlevered free cash flow = EBIT × (1 − tax rate) + depreciation and amortisation − capital expenditure − increase in working capital. From net profit: net profit + depreciation + interest × (1 − tax rate) − capital expenditure − increase in working capital.

What is the difference between levered and unlevered free cash flow? Unlevered free cash flow is before interest and loan repayments; levered free cash flow is after them. Unlevered is what the business makes for everyone who funds it; levered is what is left for the owners. A business with no debt has the same figure for both.

Why is levered free cash flow lower than unlevered? Because interest and loan repayments come out of it. Interest is tax deductible, so the after-tax cost is less than the interest itself, but repayments of the loan are not deductible and usually make the bigger difference.

Can levered free cash flow be negative? Yes. A business can make healthy unlevered free cash flow and still have negative levered free cash flow when loan repayments are large or the loan term is short. It means the owners are putting money in, or cash reserves are falling, to pay the lender. If it lasts, refinance over a longer term or pay down the debt more slowly.

Is UFCF the same as free cash flow to the firm (FCFF)? Yes, they are two names for the same measure: the cash available to all the business’s lenders and owners after tax, equipment and working capital. Levered free cash flow is close to free cash flow to equity (FCFE), the cash available to the owners after the lenders.

Is unlevered free cash flow the same as CFADS? Close, but not the same. CFADS, the cash flow available for debt service that lenders use, usually takes off only maintenance spending and the tax actually paid, so it is often higher. See the CFADS guide for a worked example.

See the cash every week, not once a year

ReportPilot reads your Xero figures and sends a short plain-English email every Monday. It covers sales and profit against last month and the same month last year, the cash in the bank against the end of last month, money owed to you that is past due and by whom, and bills due in the next two weeks against your cash. It does not calculate free cash flow or value a business, but it shows each week whether the cash is following the profit, which is where a squeeze like Mei’s shows up first. It asks Xero for read-only access, and there is a 14-day free trial with no card.