Table of Contents
What Is Levered Free Cash Flow (LFCF)? Definition and Formula
- 5 min read
- Authored & Reviewed by: CLFI Team
Levered Free Cash Flow, often referred to as LFCF, also known as Free Cash Flow to Equity (FCFE), measures the cash generated by a business that is available exclusively to equity holders after all operating expenses, reinvestment requirements, and debt-related obligations have been met. It reflects the residual cash flow remaining once lenders have been serviced.
Unlike unlevered free cash flow, levered free cash flow incorporates the effects of a company’s financing structure. This makes it particularly relevant for assessing equity value, dividend capacity, and the sustainability of shareholder returns.
Table of Contents
What Is Levered Free Cash Flow
Definition:
Levered Free Cash Flow (LFCF)
The cash flow available to equity holders after operating expenses, taxes, capital expenditure, working capital changes, and all debt-related payments.
Levered free cash flow represents the residual cash flow of a business once both operational needs and financing obligations have been satisfied. It reflects the cash that can be distributed to shareholders through dividends, share buybacks, or retained for equity-funded growth.
Because LFCF incorporates interest payments, debt repayments, and changes in net borrowing, it is directly influenced by a company’s capital structure. As a result, it provides a shareholder-focused perspective on cash generation rather than a firm-wide view.
Why LFCF Matters to Equity Holders
Levered free cash flow is central to equity analysis because it represents the cash flow that ultimately belongs to shareholders. It underpins dividend capacity, share repurchase programmes, and equity valuation models that focus on shareholder returns.
Unlike unlevered metrics, LFCF captures the financial consequences of leverage. Higher debt levels increase interest and principal payments, reducing cash available to equity holders, while lower leverage preserves flexibility but may reduce return amplification.
The main limitation of LFCF is its sensitivity to financing decisions. Changes in capital structure, refinancing, or shifts in interest rates can materially affect levered cash flows, even if underlying operating performance remains stable.
LFCF Formula Explained
Levered free cash flow is typically derived by adjusting operating cash flow for investment requirements and financing effects. A common approach starts from unlevered free cash flow and then incorporates net debt movements.
In simplified terms, LFCF equals unlevered free cash flow minus interest payments, minus debt principal repayments, plus any net debt issuance. This formulation ensures that all lender-related cash flows are reflected before determining what remains for equity holders.
Because the calculation embeds financing decisions, levered free cash flow must be interpreted alongside capital structure assumptions and refinancing plans, particularly in leveraged or rapidly growing businesses.
Related Concept:
Unlevered Free Cash Flow (UFCF)
Learn what Unlevered Free Cash Flow (UFCF) represents, how it is calculated, and why it is used in enterprise valuation to measure cash available to all capital providers before financing decisions.
Applied Example
Levered Free Cash Flow: Applied Example
From unlevered cash flow to equity cash flow — calculating what remains for shareholders after debt obligations.
Consider a company that generates unlevered free cash flow of £150 million. To determine the cash available specifically to equity holders, we must account for all debt-related cash flows including interest payments, debt repayments, and new borrowings.
Calculate Levered Free Cash Flow
| Component | Amount (£m) |
|---|---|
| Unlevered Free Cash Flow | 150.0 |
| Less: Interest Paid | (30.0) |
| Less: Debt Principal Repaid | (40.0) |
| Add: New Debt Issued | 10.0 |
| Levered Free Cash Flow (LFCF) | 90.0 |
Levered Free Cash Flow: £90 million
This £90 million represents the residual cash available to equity holders after all debt obligations have been satisfied. It is the cash flow that can be distributed as dividends, used for share buybacks, or retained for equity-financed growth.
Assess dividend sustainability and equity cash coverage
The levered free cash flow can be compared with actual dividends paid and equity reinvestment needs to determine whether the current capital allocation strategy is sustainable.
| Use of Cash | Amount (£m) |
|---|---|
| Levered Free Cash Flow | 90.0 |
| Less: Dividends Paid | (45.0) |
| Less: Share Buybacks | (20.0) |
| Retained Cash / (Shortfall) | 25.0 |
With £90 million of LFCF and £65 million distributed to shareholders (dividends + buybacks), the company retains £25 million in cash. This indicates that current shareholder distributions are sustainable and covered by operating cash generation. If distributions exceeded LFCF, the company would need to raise additional equity or debt, signaling potential financial stress.
Use LFCF for equity valuation
When forecast over time and discounted using the cost of equity, levered free cash flow forms the basis of equity valuation models. Unlike enterprise valuation (which uses UFCF and WACC), equity valuation directly measures shareholder value.
Where each year's LFCF is discounted at the cost of equity, reflecting the risk borne specifically by shareholders.
Assume the company's cost of equity is 12% and LFCF is expected to remain constant at £90 million for five years, with a terminal value thereafter.
| Year | LFCF (£m) | Discount Factor (12%) | Present Value (£m) |
|---|---|---|---|
| 1 | 90.0 | 0.8929 | 80.4 |
| 2 | 90.0 | 0.7972 | 71.7 |
| 3 | 90.0 | 0.7118 | 64.1 |
| 4 | 90.0 | 0.6355 | 57.2 |
| 5 | 90.0 | 0.5674 | 51.1 |
| Total PV of Forecast Period | 324.5 | ||
| Terminal Value (PV) | 426.8 | ||
| Equity Value | 751.3 | ||
Equity Value: £751.3 million
This valuation represents the total value to shareholders, calculated directly from the cash flows available to them after all debt obligations.
Key distinction: LFCF vs UFCF
| Metric | Unlevered FCF Approach | Levered FCF Approach |
|---|---|---|
| Cash Flow Measured | Available to all investors | Available to equity only |
| Discount Rate | WACC | Cost of Equity |
| Valuation Output | Enterprise Value | Equity Value (direct) |
| Includes Debt Flows? | No | Yes |
| Use Case | M&A, capital structure neutral | Dividend analysis, equity returns |
Learning takeaway
Levered Free Cash Flow accounts for the company's capital structure and debt obligations, providing a direct measure of cash available to shareholders. While UFCF is preferred for enterprise valuation and comparing companies with different capital structures, LFCF is essential for dividend sustainability analysis, equity valuation, and assessing the financial burden of leverage. Both metrics are complementary tools in comprehensive financial analysis.
LFCF in Corporate Finance Practice
In corporate finance practice, levered free cash flow is primarily used in equity-focused analysis, including dividend capacity assessment, share valuation, and leverage sustainability review. Because LFCF reflects cash flows available to equity holders after interest and principal obligations, it provides insight into how financing choices shape distributable cash and equity risk, particularly in capital-intensive or highly leveraged businesses.
In practice, boards, investors, and lenders use LFCF to evaluate whether current capital structures support sustainable dividends, share buybacks, or future reinvestment without increasing financial strain. However, LFCF is inherently sensitive to debt servicing profiles, refinancing assumptions, and interest rate changes, which means it can overstate equity strength during periods of accommodative credit conditions. For this reason, it is typically interpreted alongside unlevered metrics to distinguish operating performance from financial risk.
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