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Levered and unlevered free cash flow answer different financing questions. Compare the same operating, tax, capital-spending and debt schedules under both definitions, with a worked US company example.
Levered and unlevered free cash flow distinguish cash available to common equity from cash available to all capital providers. Unlevered FCF removes financing effects; levered FCF includes them under a stated definition. For this comparison, levered FCF means free cash flow to equity, including new borrowing and debt principal repayments.
Use unlevered free cash flow, also called free cash flow to the firm or FCFF, when assessing operations and reinvestment independently of the debt schedule. Use free cash flow to equity, or FCFE, when assessing the cash remaining for common shareholders after debt financing.
The CFA Institute's free cash flow valuation reading distinguishes FCFF as cash available to all investors and FCFE as cash available to common stockholders. That distinction helps corporate finance teams compare projects, assess financing capacity and explain why improved operating performance may not improve equity cash availability.
Neither measure is the company's bank balance. Both are period calculations with explicit assumptions about taxes, reinvestment and financing. The free cash flow glossary covers the usual operating-cash-flow-minus-capex definition; that simpler measure needs an extra debt reconciliation before it becomes FCFE.
| Question | Unlevered FCF / FCFF | Levered FCF defined as FCFE |
|---|---|---|
| Whose cash is measured? | All capital providers | Common equity holders |
| Starting earnings in this example | Operating profit, or EBIT | Net income after interest |
| Tax basis | Taxes on operating profit without interest deductions | Taxes after the assumed interest deduction |
| Cash reinvestment | Deduct capex and operating working-capital investment | Deduct the same operating reinvestment |
| Interest | Excluded as a financing effect | Included through net income |
| New debt and principal repayments | Excluded | Include net borrowing |
| Useful management question | How much cash do operations generate after reinvestment? | How much remains after the debt schedule? |
For a simple company with deductible interest, one tax rate and no other noncash adjustments:
Unlevered FCF = EBIT × (1 − Tax rate) + Depreciation and amortization − Cash capex − Increase in operating working capital
FCFE = Net income + Depreciation and amortization − Cash capex − Increase in operating working capital + New debt − Debt principal repaid
These formulas assume net income already deducts interest. Do not subtract it again. A positive working-capital increase is a cash use in both calculations.
Gather the P&L, tax reconciliation, capital-spending register, operating balance-sheet schedules and debt roll-forward. A finance reviewer should be able to trace each input to the same company and reporting period. Treat preferred stock or other capital claims separately if present; the example below has only common equity and ordinary debt.
The unlevered FCF article owns the detailed operating-profit reconciliation. Here the purpose is to compare the two views using the same underlying activity.
A US industrial supplier reports the following annual amounts. The 25% tax rate is a simplifying assumption, not a statement about the company's statutory rate. Assume all interest is currently deductible, taxes equal the calculated expense, and there are no deferred taxes or other noncash charges beyond depreciation and amortization. All USD amounts are exact.
| Supplied input | Amount |
|---|---|
| EBIT (USD) | 900,000 |
| Depreciation and amortization (USD) | 150,000 |
| Interest expense and cash interest (USD) | 100,000 |
| Assumed tax rate | 25% |
| Increase in operating working capital (USD) | 80,000 |
| Cash capex (USD) | 250,000 |
| New debt proceeds (USD) | 120,000 |
| Debt principal repaid (USD) | 200,000 |
Operating taxes before financing are $900,000 × 25% = $225,000. After-interest taxable income is $900,000 − $100,000 = $800,000, with taxes of $200,000 and net income of $600,000.
| Calculation step | Unlevered view (USD) | Equity view (USD) |
|---|---|---|
| EBIT | 900,000 | 900,000 |
| Less: interest expense | 0 | 100,000 |
| Less: applicable income taxes | 225,000 | 200,000 |
| After-tax earnings subtotal | 675,000 | 600,000 |
| Add: depreciation and amortization | 150,000 | 150,000 |
| Less: working-capital investment | 80,000 | 80,000 |
| Less: cash capex | 250,000 | 250,000 |
| Add: new debt proceeds | 0 | 120,000 |
| Less: debt principal repaid | 0 | 200,000 |
| Cash flow under the stated definition | 495,000 | 340,000 |
The unlevered calculation is $675,000 + $150,000 − $80,000 − $250,000 = $495,000. The equity calculation is $600,000 + $150,000 − $80,000 − $250,000 + $120,000 − $200,000 = $340,000.
The result is economically coherent: the business generates cash after operating reinvestment, while financing consumes part of the amount available to equity. Neither column deducts dividends because FCFE measures capacity before distributions to shareholders.
Under these assumptions, the operating cash flow calculation starts with net income:
| Equity cash reconciliation | Amount (USD) |
|---|---|
| Net income | 600,000 |
| Add: depreciation and amortization | 150,000 |
| Less: operating working-capital investment | 80,000 |
| Operating cash flow | 670,000 |
| Less: cash capex | 250,000 |
| Operating cash flow less capex | 420,000 |
| Add: new debt | 120,000 |
| Less: principal repayments | 200,000 |
| FCFE | 340,000 |
This independently reaches the equity column. It also shows the naming trap: $420,000 is operating cash flow less capex, while $340,000 includes net borrowing. Those figures answer different questions even if both appear under a heading called levered free cash flow.
The SEC's non-GAAP guidance specifically warns against implying that FCF necessarily represents discretionary cash when mandatory debt service has not been deducted. Keep the formula attached to every management report and peer comparison.
For an operating review, compare FCFF across periods while holding the tax methodology consistent. Operations and FP&A can then examine collection, inventory, cost and capital-spending drivers without confusing them with a refinancing decision.
For a financing review, treasury needs the FCFE view alongside the actual payment calendar. New borrowing can raise FCFE without any improvement in operations; principal repayments can lower it while reducing future obligations. Use a cash flow forecast to place those payments in the periods when they fall due.
Neither view replaces a review of reinvestment quality. A capex deferral raises both figures today, but it can postpone maintenance or capacity the business still needs. The article on improving free cash flow addresses the operating and spending choices behind such changes.
Bring your earnings, tax, working-capital, capex and debt schedules in a file or Google Sheet. Covirage maps the columns, and its tools compute and check both stated cash-flow views; the external AI model explains their differences with every figure traced to its rows. Create a free Covirage account and bring a sample of your own data.
See FP&A reporting with Covirage for the supporting reporting workflow.
It can be, but the label is inconsistent. FCFE includes net borrowing as well as interest and reinvestment. A company may instead call operating cash flow minus capex levered FCF. Ask for the formula and debt treatment before comparing figures.
It aims to measure operating cash without the effect of debt financing. Taxes on operating profit exclude the interest tax benefit. Actual cash tax payments can differ, so a historical reconciliation should show the tax assumptions and timing differences separately.
Yes. Interest and principal repayments can absorb the operating cash remaining after reinvestment, especially when little new debt is raised. That result describes a financing requirement for equity; it does not automatically mean the underlying operations generate negative cash.
No. FCFE is a calculated capacity measure under specified assumptions, not a distribution instruction. Treasury still needs to consider cash reserves, payment dates, restrictions, other commitments and management's investment plans before recommending a dividend.