In this revised tutorial, you’ll learn why Unlevered Free Cash Flow is important, the items you should include and exclude, and how to calculate it for real companies in different industries. You’ll also get answers to the most common questions we receive about this topic at the end.

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Table of Contents:

1:05 Why Unlevered Free Cash Flow Matters

2:09 Defining Unlevered FCF

3:51 Unlevered FCF for Steel Dynamics

12:08 Unlevered FCF for Snap

13:51 Common Questions and Answers About Unlevered FCF

18:32 Recap and Summary

Resources:

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Lesson Outline:

A DCF is split into the Explicit Forecast Period (Part 1) and the Terminal Period (Part 2).

You always start in Part 1 by projecting the company’s Cash Flows over 510 years, and sometimes more than that, and you almost always use Unlevered Free Cash Flow because it doesn’t depend on the company’s capital structure, it’s faster and easier, and it gets you the most consistent results.

Unlevered Free Cash Flow should reflect only items that are:

1) Related to or “available” to all investor groups in the company – think of it as “Free Cash Flow to ALL Investors”; and

2) Recurring for the company’s corebusiness operations.

Unlevered FCF corresponds to Enterprise Value, which represents the value of the company’s corebusiness Assets to ALL investors in the company.

As a result, you ignore most items on the financial statements, and Unlevered FCF usually includes only:

1) Revenue
2) COGS and Operating Expenses
3) Taxes
4) Depreciation & Amortization (and sometimes other noncash charges)
5) Change in Working Capital
6) Capital Expenditures

You IGNORE Net Interest Expense, Other Income / (Expense), most noncash adjustments, most of the CFI section, and the CFF section on the CFS.

Example for Steel Dynamics:

We include the common items above, and we ignore the Asset Impairment Charges (nonrecurring), Net Interest Expense (only available to Debt investors), and Other Income / Expense (noncorebusiness activity).

We include but modify the Income Tax Expense, and instead of Net Income on the CFS, we use NOPAT, equal to EBIT * (1 – Tax Rate), instead.

On the Cash Flow Statement, we include the Depreciation & Amortization addback, exclude Impairment Charges and Gains/Losses (nonrecurring), and exclude StockBased Compensation (affects only the Equity investors, changes share count, and is not a real noncash expense).

We do include Deferred Income Taxes as well because a DCF should reflect the company’s actual Cash Taxes paid, but they decrease as a % of Income Taxes over time and should not be a major value driver for most companies.

Then, we keep everything in Working Capital, we keep CapEx in Cash Flow from Investing but drop everything else, and we ignore everything in Cash Flow from Financing (items are nonrecurring, or related to just Equity or just Debt investors).

Example for Snap:

It’s very similar; keep Revenue, Cost of Revenue, and all Operating Expenses, modify the Income Tax figure, use NOPAT rather than Net Income, and include D&A, Deferred Taxes, the Change in Working Capital, and CapEx.

We might include the Purchases of Intangible Assets as well, depending on the company’s plans and how they’re contributing to the business.