Unlevered Free Cash Flow - definition & overview
Contents
What is Unlevered Free Cash Flow?
Unlevered Free Cash Flow (UFCF) is a financial metric that shows the cash a small business generates from its operations after accounting for expenses and reinvestment in the business, but before considering any debt or debt servicing costs (interest payments).
Why is Unlevered Free Cash Flow (UFCF) important for Australian small businesses?
For Aussie small businesses, UFCF is a valuable tool to understand their true financial health. It reveals how much cash the business is churning out independent of how it's financed. This helps with:
- Decision-making: Knowing your UFCF helps you decide if you have enough cash for things like expansion, repaying shareholders, or building a financial buffer.
- Investor attractiveness: A positive UFCF can be attractive to potential investors as it indicates a business that generates its own cash flow.
How is Unlevered Free Cash Flow calculated?
Calculating UFCF involves looking at your financial statements. Here's a simplified formula:
UFCF = EBIT (1 - Tax Rate) + Depreciation & Amortisation - Changes in Working Capital - Capital Expenditure
- EBIT (Earnings Before Interest and Taxes): This reflects your business's profitability before considering interest and taxes.
- Tax Rate: The percentage of your profit that goes to the Australian Taxation Office (ATO).
- Depreciation & Amortisation: These are non-cash expenses that account for the wear and tear of your assets (depreciation) and intangible assets (amortisation).
- Changes in Working Capital: This reflects the difference between your current working capital (inventory, accounts receivable) and what it was in the previous period. An increase requires more cash to be tied up, so it's subtracted.
- Capital Expenditure: This is the money you spend on acquiring or upgrading fixed assets (property, equipment).
Limitations of Unlevered Free Cash Flow
- UFCF doesn't consider the impact of debt. A business with high debt might have a low UFCF even if it's profitable.
- It relies on past financial data and may not reflect future performance.
For Australian small businesses, UFCF is a key metric to understand your cash flow generation ability. While it has limitations, it provides valuable insights for informed financial decisions.
Learn about Levered Free Cash Flow here.
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