What is Levered Free Cash Flow?

Levered Free Cash Flow (LFCF) is a financial metric that measures the amount of cash a company has left after paying all its operating expenses and meeting its debt obligations. It shows the actual cash available to equity shareholders.

Unlike unlevered free cash flow, which ignores interest payments, LFCF takes debt servicing into account. This makes it a more accurate indicator of a company’s financial health from an investor’s perspective.

Levered Free Cash Flow is especially useful for understanding a company’s ability to generate returns for shareholders while managing its debt responsibly.

How to Calculate Levered Free Cash Flow

The formula for Levered Free Cash Flow is:
LFCF = Operating Cash Flow - Capital Expenditures - Debt Repayments

You start with the operating cash flow, which is found on the cash flow statement. Then subtract capital expenditures (CapEx), which reflect investments in property or equipment. Lastly, subtract any mandatory debt repayments.

For example, if a company has an operating cash flow of $500,000, spends $100,000 on CapEx, and repays $50,000 in debt, its LFCF is $500,000 - $100,000 - $50,000 = $350,000.

Why Use Levered Free Cash Flow?

Levered Free Cash Flow gives investors a clearer picture of how much cash a company truly has available for dividends, reinvestment, or expansion after fulfilling its debt responsibilities.

It's particularly valuable when analyzing companies with substantial debt, as it reveals how effectively they manage obligations while generating value for shareholders.

Lenders also use this metric to assess a company’s risk level. A negative LFCF might raise red flags about future solvency or growth potential.

Interpreting Levered Free Cash Flow

A positive LFCF indicates that a company is generating enough cash to cover debt payments and still have money left for shareholders or reinvestment. This is a sign of strong financial health.

A negative LFCF doesn't always signal trouble. Startups or growing firms often invest heavily, leading to temporarily negative cash flows that support long-term growth strategies.

To interpret LFCF meaningfully, it should be compared over time or against industry peers. Trends can reveal whether a company is improving its financial flexibility or accumulating too much debt.

Practical Applications

Investors use LFCF to evaluate a company's ability to pay dividends or repurchase shares. It's a key factor in equity valuation models and financial forecasting.

Financial analysts incorporate LFCF into discounted cash flow (DCF) models to estimate intrinsic value. It helps determine whether a company is undervalued or overvalued in the market.

Managers also rely on LFCF to make strategic decisions. It informs choices on whether to reduce debt, invest in new projects, or return capital to shareholders.

Conclusion

Levered Free Cash Flow is a vital indicator of a company’s ability to generate real, spendable cash after all obligations. It offers deeper insights than many profitability metrics.

By factoring in debt payments, LFCF provides a clearer view of financial health and is an essential tool for investors, analysts, and corporate decision-makers alike.