Levered free cash flow is a financial metric that is used to measure the amount of cash available to a company after accounting for its debt obligations. This metric is important because it provides insight into a company's ability to generate cash flow and pay off its debt. Understanding levered free cash flow can help investors make informed decisions about whether to invest in a company or not.
To understand levered free cash flow, it is first necessary to understand what free cash flow is. Free cash flow is the amount of cash that a company generates from its operations after subtracting capital expenditures. In other words, it is the cash that a company has left over after it has paid for the equipment and other assets that it needs to run its business.
Levered free cash flow takes free cash flow a step further by factoring in the company's debt obligations. This metric subtracts the amount of interest and principal payments that a company has to make on its debt from its free cash flow. The resulting number is the company's levered free cash flow.
Levered free cash flow is important because it gives investors a more accurate picture of a company's financial health. A company that has strong free cash flow but also has a large amount of debt may not be as financially stable as it appears. By factoring in the company's debt obligations, levered free cash flow provides a more complete picture of a company's ability to generate cash flow and pay off its debt.
There are several ways to calculate levered free cash flow, but the most common method is as follows:
Levered Free Cash Flow = Free Cash Flow – (Interest Expense x (1 – Tax Rate)) – Principal Repayments
Free cash flow is calculated by subtracting capital expenditures from operating cash flow. Interest expense is the amount of interest that a company pays on its debt, and the tax rate is the company's income tax rate. Principal repayments are the amount of principal that a company pays on its debt.
It is important to note that levered free cash flow is not the same as cash flow from operations. Cash flow from operations is the amount of cash that a company generates from its day-to-day operations, while levered free cash flow takes into account the company's debt obligations. A company can have strong cash flow from operations but still struggle to generate enough cash to pay off its debt.
One of the key benefits of levered free cash flow is that it allows investors to compare companies across different industries. Because levered free cash flow takes into account a company's debt obligations, it provides a more standardized measure of a company's financial health. This makes it easier for investors to compare companies in different industries and make informed investment decisions.
Another benefit of levered free cash flow is that it can help investors identify companies that may be undervalued or overvalued. A company with strong levered free cash flow may be undervalued by the market because investors are not fully appreciating the company's ability to generate cash flow and pay off its debt. Conversely, a company with weak levered free cash flow may be overvalued by the market because investors are not fully appreciating the company's debt obligations.
There are several factors that can affect a company's levered free cash flow. One of the most important factors is the amount of debt that a company has. Companies with high levels of debt will have more interest and principal payments to make, which will reduce their levered free cash flow. Companies with lower levels of debt will have more levered free cash flow available to them.
Another factor that can affect a company's levered free cash flow is its capital expenditures. If a company is investing heavily in new equipment or other assets, it may have less free cash flow available to pay off its debt. Conversely, if a company is not investing heavily in new assets, it may have more free cash flow available to pay off its debt.
Levered free cash flow is a powerful financial metric that is used to measure a company's ability to generate cash flow and pay off its debt. This metric takes into account a company's debt obligations, which provides a more accurate picture of its financial health. By understanding levered free cash flow, investors can make more informed decisions about whether to invest in a company or not.