Free cash flow formula
Free cash flow is the cash a business has left after paying for the equipment and working capital it needs to keep running. It is cash from operations minus capital expenditures.
- Free cash flow
FCF = cash from operations − capex
The version on a cash flow statement. It is after interest, before any debt is repaid.
- Unlevered free cash flow
UFCF = EBIT × (1 − tax rate) + D&A − capex − increase in NWC
What a DCF discounts. It ignores how the company is funded, so it is the cash for lenders and shareholders together.
- Levered free cash flow
LFCF = cash from operations − capex − required debt repayment
The cash left for shareholders once lenders get their interest and the principal due this year.
- How they connect
LFCF = UFCF − interest × (1 − tax rate) − required debt repayment
Take off interest after the tax saving it creates, then the principal due.
Inputs
Worked example
- Unlevered free cash flow
- EBITDA1,000.0 − 740.0
- $260.0m
- EBIT260.0 − 60.0 D&A
- $200.0m
- Less taxes on EBIT200.0 × 25%
- ($50.0m)
- NOPAT
- $150.0m
- Plus D&A
- $60.0m
- Less capital expenditures
- ($80.0m)
- Less increase in working capital
- ($30.0m)
- Unlevered free cash flow150.0 + 60.0 − 80.0 − 30.0
- $100.0m
- After interest and debt repayment
- Net income(200.0 − 20.0 interest) × (1 − 25%)
- $135.0m
- Cash from operations135.0 + 60.0 − 30.0
- $165.0m
- Free cash flow165.0 − 80.0 capex
- $85.0m
- Levered free cash flow85.0 − 25.0 required repayment
- $60.0m
How to calculate free cash flow
Four steps, from revenue to cash.
1. Get to EBIT
Revenue minus operating costs gives EBITDA. Take off depreciation and amortization to get EBIT.
2. Tax it
For unlevered free cash flow, tax EBIT as if the company had no debt. The result is NOPAT.
3. Turn profit into cash
Add back D&A, because it was never paid in cash this year. Subtract capex and the increase in net working capital, because both are cash the business spent.
4. Pay the lenders for the levered version
Subtract interest after the tax it saves, then the required debt repayment. What is left is levered free cash flow, the cash for shareholders.
Explain free cash flow out loud
Knowing the formula is half of it. Interviewers ask you to walk from revenue to free cash flow and to say what each adjustment does. Practice the answer with an AI interviewer.
Questions people ask
What is the difference between free cash flow and net income?
Net income is an accounting profit and free cash flow is cash. A company can show a profit and still have little free cash flow if it spends on equipment or ties up cash in inventory and receivables. In the example, net income is $135m and free cash flow is $85m.
What is the difference between levered and unlevered free cash flow?
Unlevered free cash flow is before anything goes to lenders, so it is the cash for lenders and shareholders together. Levered free cash flow is after interest and the required debt repayment, so it is the cash for shareholders. In the example they are $100m and $60m. Some sources call cash from operations minus capex levered free cash flow, with no repayment taken off, which here is $85m.
Why subtract the increase in working capital?
Growth ties up cash in inventory and receivables before it comes back as sales. That cash is spent even though the income statement does not show it, so it comes off.
Is negative free cash flow always bad?
No. A fast-growing company that spends heavily on equipment can be negative while it builds something worth more. What matters is whether the spending earns a return and whether the company has the cash to keep going.