Levered cash flow – also called levered free cash flow – is an important figure in determining the effectiveness and profitability of a company. The calculations made to determine a company’s levered cash flow are an important feature of its cash flow report, and provide one means of assessing a company’s profitability and attractiveness to investors.
Unlevered Cash Flow
To determine levered cash flow it is first essential to calculate a company’s unlevered cash flow. This is essentially the capital that a company generates before it has paid its debts or the required interest on those debts. It is calculated by subtracting capital expenditure, taxes and other changes in working capital from a company’s EBITDA, which stands for “earnings before interest, taxes, deprecation and amortization."
Levered Cash Flow
Levered cash flow is the unlevered cash flow minus all outstanding remittances that the company must make, including interest repayments on debt. Levered cash flow is therefore an important calculation in determining a company’s credit record, ability to meet its debt commitments and effectiveness at using company money.
The figure resulting from calculating levered free cash flow is a more accurate reflection of the company’s financial health, as it includes all outstanding commitments. If the resultant figure is negative, the company’s expenditure is greater than its income, meaning that it is not making an overall profit. This may be because it has made a capital investment in new technology, say, or upgrading equipment that should see its performance increase in the future. However, it may be that it simply is not performing adequately to generate sufficient revenue, in which case its borrowing costs rise and its viability is cast into doubt.
If a company has a positive levered cash flow, it can choose to do one of two things with the surplus capital. The first is to reinvest it in the company. This can help to expand the company, which should make for a better long-term performance and, thus, return for investors.
The second option for positive levered cash flow is to distribute it amongst the shareholders. This is done in the form of a dividend payable per share that the shareholder owns. Companies are unlikely to spend their entire surplus on a dividend (they need some liquid capital to cover unforeseen circumstances) but may deliver a high one to attract investors. A high dividend may prompt more shareholders to invest in the company, as it signals a strong performance and suggests the opportunity to earn a payout on an investment as well as experiencing capital growth.
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