How to Calculate Unlevered Cash Flow

Unlevered cash flow is a critical financial metric used to assess a company's ability to generate cash without the impact of its capital structure. Calculating unlevered cash flow involves understanding and computing various components of a company's financial performance, excluding the effects of debt. Here's a comprehensive guide to calculating unlevered cash flow:

1. Start with Operating Income (EBIT): Operating income, or Earnings Before Interest and Taxes (EBIT), is the profit a company makes from its operations before interest and taxes are subtracted. It is the first step in determining unlevered cash flow.

2. Adjust for Non-Cash Expenses: Add back non-cash expenses to EBIT. Common non-cash expenses include depreciation and amortization. These expenses are accounting entries and do not involve actual cash outflows.

3. Subtract Taxes: Calculate taxes based on the EBIT and adjust for the tax shield benefits, but note that unlevered cash flow focuses on the company's performance without debt, so the tax calculation might differ from levered scenarios.

4. Adjust for Changes in Working Capital: Working capital adjustments reflect changes in current assets and current liabilities. An increase in working capital represents an outflow of cash, whereas a decrease represents an inflow.

5. Subtract Capital Expenditures (CapEx): Deduct capital expenditures required to maintain or expand the company's asset base. These are actual cash outflows used for purchasing or upgrading physical assets.

The formula for unlevered cash flow is:

Unlevered Cash Flow = EBIT + Depreciation & Amortization - Taxes - Changes in Working Capital - Capital Expenditures

This formula helps investors and analysts evaluate a company's operational efficiency and cash generation capabilities without the distortion of its financing structure.

Example Calculation:
Assume a company has the following financials:

• EBIT: $500,000
• Depreciation & Amortization: $50,000
• Taxes: $100,000
• Changes in Working Capital: $20,000 (increase)
• Capital Expenditures: $30,000

Using the formula:

Unlevered Cash Flow = $500,000 + $50,000 - $100,000 - $20,000 - $30,000
Unlevered Cash Flow = $400,000

This unlevered cash flow indicates the company's cash generation capability without considering its debt obligations. It is a useful metric for evaluating a company’s performance from an operational standpoint, providing a clearer picture of financial health and operational efficiency.