Unlevered Free Cash Flow

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Last updated: February 3, 2023

Unlevered free cash flow ("UFCF") is the cash flow available to all providers of capital, including debt, equity, and hybrid capital. A business or asset that generates more cash than it invests provides a positive FCF that may be used to pay interest or retire debt (service debt holders), or to pay dividends or buy back stock (service equity holders).

Projection Intervals

Most DCF analyses use annual projection intervals. Theoretically, the shorter the projection interval, the more accurate the DCF valuation. However, projecting smaller intervals usually requires several additional assumptions that may more than offset the additional accuracy. Certain situations (for example, seasonal businesses) require adjustments to projection intervals to more accurately reflect the timing of UFCF. Additionally, using an annual projection interval may require a shorter stub period for the first interval (to reflect that a deal would close mid-year, for example).

Projection Period

UFCFs should be projected to the time when the business attains maturity and experiences steady-state growth and profitability (growth and profitability that can be sustained over a long period of time without substantial new investment). Most DCF analyses use 5 or 10-year projection periods. Projecting cash flows over a longer period is inherently more difficult. A shorter projection period increases the accuracy of the projections, but also places greater emphasis on the contribution of terminal value (TV) to the total valuation.

Calculation of Unlevered Free Cash Flow

EBIT
(+)	Amortization of non-deductible goodwill
EBITA
(-)	Taxes on EBITA (EBITA × projected tax rate)
Unlevered net income
(+)	D&A and other non-cash charges affecting EBIT (excl. non-deductible goodwill amortization)
(+)	Changes in deferred taxes
(-)	Capital expenditures
(-)	Increase in non-cash working capital
Unlevered free cash flow (UFCF)

Exhibit A – Unlevered Free Cash Flow Calculation

The following spreadsheet shows how to calculate unlevered free cash flow. The blue inputs are hard-coded for simplicity, but would normally be linked to items on the income and cash flow statements.

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Unlevered Free Cash Flow

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Income Statement and Cash Flow Items

Download our operating model template to see how to project income statement items over the projection period. The following exhibit discusses the various inputs necessary to calculate EBIT.

Exhibit B – Income Statement and Cash Flow Items

Variable	Sources	Hints
Sales	Client projections, research reports, and historical sales growth	Sales growth should converge to a long-term, sustainable rate. Projection period should extend until the business reaches steady-state.
Gross Profit	Client projections, research reports, and historical gross profit margins	Projected profitability should be based on expectations about the future rather than historical performance.
EBIT	Client projections, research reports, and historical EBIT margins	EBIT should include recurring other income/expenses unless assets generating such income/expenses are added/subtracted in the calculation of net debt. EBIT should exclude goodwill amortization per SFAS 142 if CY2001 or an earlier year is used to arrive at EBIT margin
Tax Rate	Client projections, research reports, and historical tax rates	Use best judgment to determine the appropriate tax rate (e.g. marginal vs. effective) based on the circumstances and available information.
Depreciation	Client projections, research reports, and historical depreciation as a % of sales, relationship to CapEx, latest gross PP&E divided by an estimated average useful life	Often projected as a % of sales for convenience. Need to consider the relationship between depreciation and CapEx (they should converge somewhat by the end of the projection period). Obtain depreciation from the cash flow statement rather than the income statement.
Amortization	Client projections, research reports, and historical amortization amount or as a % of sales	Amortization should exclude goodwill amortization per SFAS 142, unless projected EBIT also includes goodwill amortization.
CapEx	Client projections, research reports, and historical CapEx as a % of sales	CapEx should converge toward depreciation over the projection period as the business reaches a mature, steady state.

Balance Sheet Items

Download our operating model template to see how to project balance sheet working capital items over the projection period. Non-cash working capital excludes cash and cash equivalents, short-term borrowings, and the short-term portion of long-term debt. Non-cash working capital should be estimated by separately projecting its various components when possible. As a surrogate, non-cash working capital may be projected as a percent of sales. Use the following equations to separately project working capital items:

Exhibit C – Working Capital Equations

Accounts Receivable Days = (Accounts Receivable ÷ Sales) × 365 Days
Inventory Days = (Inventory ÷ COGS) × 365 Days
Accounts Payable Days = (Accounts Payable ÷ COGS) × 365 Days

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