What is the difference between levered and unlevered free cash flow?

Introduction to levered and unlevered free cash flow

Free cash flow is the cash a business generates after covering operating costs and capital expenditures. It comes in two main forms, distinguished by whether the effect of debt has been taken into account.

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Unlevered free cash flow, also called free cash flow to the firm (FCFF), is the cash the business produces before any financing costs. It is the cash available to everyone who has a claim on the company, both lenders and shareholders. Levered free cash flow, also called free cash flow to equity (FCFE), is what remains after the company has paid interest and made mandatory debt repayments. It is the cash available to equity holders alone.

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The terms "levered" and "unlevered" refer to leverage, meaning debt. Unlevered free cash flow is measured as if the company had no debt; levered free cash flow reflects its actual debt obligations.

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How they differ

The distinction comes down to where debt sits in the calculation.

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• Unlevered free cash flow (FCFF) is calculated before interest and debt repayments. Because it excludes the effect of financing, it reflects the cash-generating power of the business itself, independent of how it is funded.
• Levered free cash flow (FCFE) starts from a similar place but subtracts interest paid and mandatory principal repayments, and reflects any new debt drawn. What is left is the cash genuinely available to shareholders after the lenders have been served.

For a company with no debt, the two figures are effectively the same. The more debt a company carries, the wider the gap between them, since a larger share of its cash is consumed by servicing that debt before anything reaches equity holders.

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Why the distinction matters in valuation

The main reason the difference matters is that it determines which discount rate to use in a discounted cash flow valuation.

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Unlevered free cash flow is discounted at the weighted average cost of capital (WACC), which blends the required returns of both debt and equity investors. This is appropriate because the cash is available to both groups, and the result is an enterprise value, the value of the whole business regardless of financing.

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Levered free cash flow is discounted at the cost of equity, since the cash is available only to shareholders. The result is an equity value directly. Match the cash flow to its corresponding rate; using WACC on levered cash flow, or the cost of equity on unlevered cash flow, gives a figure that means nothing.

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Unlevered free cash flow is the more common choice in valuation because it allows cleaner comparison between companies with different capital structures. Removing the effect of financing means two businesses can be compared on the strength of their operations alone.

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When each is used

Each measure suits different purposes.

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Unlevered free cash flow is used for enterprise valuation and for comparing companies on a like-for-like basis, because it is unaffected by financing decisions. It answers what the business is worth as an operating entity.

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Levered free cash flow is used to understand what is actually available to equity holders after debt is serviced, which matters to shareholders assessing dividend capacity and to anyone evaluating a business with significant leverage. It answers what the owners can take out once the lenders are paid.

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Both build on the same foundation of operating cash flow less capital expenditure, differing only in how they treat debt.

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How Atlar can help

Whether measured before or after debt, free cash flow rests on an accurate view of the cash a business generates from operations. Atlar consolidates balances and transactions from all your banks, ERP, and payment platforms into one real-time view, giving finance teams a dependable base for the operating cash figures that underpin any free cash flow measure.

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With Atlar, teams track cash across all accounts and entities, analyze cash flow over any period with cash reporting, and project forward using cash flow forecasting. Customers including Acne Studios, GetYourGuide, and Forto use Atlar as the source of truth for their cash.

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To learn more, explore our cash management solution or book a demo with our team.