Calculating Unlevered Free Cash Flow (UFCF)
Master how to translate operating performance into actual free cash flow — using a structured formula, clear intuition, and worked banker-style examples.
Analyst Objective
Learn to compute unlevered free cash flow cleanly from any 3-statement model — and explain every step in interviews.
What You’ll Learn in This Lesson
1What Is Unlevered Free Cash Flow?
Unlevered Free Cash Flow (UFCF) — also called Free Cash Flow to the Firm (FCFF) — measures the cash a company generatesbefore financing decisions. It reflects pure operating performance and is the foundation of any DCF model.
Why UFCF Matters
• Used to calculate enterprise value in DCFs.
• Strips out capital structure effects (interest, debt repayments).
• Shows the company’s cash generation capability from core operations.
• More stable and comparable across companies than net income.
Conceptual Formula
EBIT × (1 − Tax Rate)+ Non-Cash Charges (D&A, SBC, etc.)
− ΔNWC
− CapEx
Unlevered vs Levered Free Cash Flow — Why It Matters for a DCF
Unlevered FCF (UFCF / FCFF)
- Calculated before interest and debt repayments.
- Cash flow available to all capital providers (debt & equity).
- Discounted at the WACC → gives enterprise value.
- Standard for DCF tests and banking models.
Levered FCF (to Equity)
- Starts from Net Income or CFO and subtracts debt service.
- Cash flow available only to equity holders.
- Discounted at the cost of equity → gives equity value directly.
- Useful for highly levered or project-finance situations.
Step 1 — Start from EBIT
DCF valuation always begins with operating profit, not net income.
Numerically here: 80 × 0.75 + 18 + 4 − 6 − 20 = 56
2Step 1 — EBIT → NOPAT (Tax-Affected Operating Income)
UFCF must be calculated on an unlevered basis. That means removing anything that depends on capital structure (interest expense, debt issuance, preferred dividends). So instead of starting with net income, we begin withEBIT (Earnings Before Interest & Taxes).
EBIT captures pure operating profit before financing decisions. By applying the tax rate to EBIT, we getNet Operating Profit After Tax (NOPAT), which represents after-tax operating performance available to all capital providers.
Tax Rate = 25%
NOPAT = EBIT × (1 − T) = 75M
Step 1 — Identify EBIT
Start from operating profit, not net income.
In words: take operating profit (EBIT), apply the operating tax rate, and ignore any effects of interest or capital structure.
Example — EBIT to NOPAT Conversion
Revenue = 450
Operating Costs = (360)
EBIT = 90
Tax Rate = 25%
NOPAT = 90 × (1 − 0.25) = 67.5
3Step 2 — Add Back Non-Cash Charges
The Income Statement includes several expenses that reduce EBIT but donot represent current-period cash outflows. We add these back when moving from NOPAT to cash flow because the company didn’t actually spend cash on them this period.
Depreciation
Allocates past CapEx over asset life. Reduces EBIT but no current cash leaves the business.
Amortization
Similar to depreciation, but for intangibles (software, patents, customer lists).
Stock-Based Compensation (SBC)
Non-cash expense for equity awards. Economic cost to shareholders but not a cash outflow today.
NOPAT to Pre-Working Capital Cash Flow
NOPAT+ Depreciation & Amortization
+ Stock-Based Compensation
+ Other Non-Cash Charges
= Pre-WC Operating Cash Flow
Example — Adding Back Non-Cash Charges
NOPAT = 60
Depreciation = 18
Amortization = 4
SBC = 6
Other Non-Cash = 2
Pre-WC Cash Flow = 60 + 18 + 4 + 6 + 2 = 90
Start from NOPAT
We begin with after-tax operating profit.
We add back non-cash charges because the cash left the business in a different period (for CapEx) or is paid in equity instead of cash (for SBC).
In interviews, be clear:We add back non-cash charges not because they’re “free,”but because the cash cost was paid in a different period (for CapEx) or is paid in equity instead of cash (for SBC).
4Step 3 — Working Capital & ΔNWC
Working capital is where many interns and analysts make mistakes. The rule is simple: if cash is tied up in operations, UFCF falls. If the business releases cash from working capital, UFCF rises.
Operating Working Capital (OWC)
A common definition used in DCF modeling:
The change in OWC (ΔNWC) affects cash flow:
• OWC ↑ → more cash invested → UFCF ↓ • OWC ↓ → cash freed up → UFCF ↑
Accounts Receivable (AR)
AR ↑ → customers owe more → cash down. AR ↓ → customers paying → cash up.
Inventory
Inventory ↑ → you bought more goods → cash down. Inventory ↓ → you’re selling inventory → cash up.
Accounts Payable (AP)
AP ↑ → you delay paying suppliers → cash up. AP ↓ → you pay faster → cash down.
ΔNWC Cash Impact (Analyst Shortcut)
ΔNWC (Cash Impact) = −ΔAR − ΔInventory − ΔPrepaids+ ΔAP + ΔAccruals + ΔDeferred Revenue
If ΔNWC > 0 → cash outflow (UFCF ↓) If ΔNWC < 0 → cash inflow (UFCF ↑)
Example — ΔNWC Effect on UFCF
AR ↑ by 8
Inventory ↑ by 5
AP ↑ by 6
Accruals ↑ by 1
Cash impact = −8 − 5 + 6 + 1 = −6
ΔNWC = +6 → UFCF decreases by 6
Working Capital Shock: AR Increases
AR ↑ 8 → customers take longer to pay, so cash goes down.
Rule of thumb: if more cash is tied up in working capital (ΔNWC > 0), UFCF goes down. If working capital is released (ΔNWC < 0), UFCF goes up.
Many technical interviews now include a ΔNWC scenario. They’ll say: “AR goes up by 10, AP by 4, Inventory by 3 — walk me through the three statements and UFCF.” If you can answer that calmly, you instantly stand out.
5Step 4 — CapEx (Capital Expenditures)
Capital Expenditures (CapEx) are the largest recurring cash outflow excluded from the Income Statement. CapEx represents actual cash paid for long-term assets — new equipment, servers, buildings, software development, manufacturing lines, etc.
Why CapEx Is Critical in UFCF
• It's a real cash outflow, unlike depreciation.
• Determines future productive capacity of the business.
• Drives the PP&E roll-forward, which drives future depreciation.
• Too aggressive or too weak CapEx assumptions can distort valuation.
Growth CapEx
Investments that expand operating capacity. Examples: new factories, cloud servers, store openings.
Maintenance CapEx
Required to sustain current operations. Examples: replacing equipment, mandatory software upgrades.
PP&E Roll-Forward
Beginning PP&E+ CapEx
− Depreciation
= Ending PP&E
Example — CapEx Effect on UFCF
Pre-WC Cash Flow = 100
CapEx = (35)
UFCF = 100 − 35 = 65
Start from Pre-WC Cash Flow
We begin with operating cash flow before any investment in PP&E.
CapEx hits cash immediately but is only expensed over time through depreciation. That’s why we subtract CapEx in UFCF and let the PP&E roll-forward handle future depreciation.
CapEx is the biggest judgment call in DCF modeling. Underestimating CapEx artificially boosts UFCF → inflates valuation. Always tie CapEx assumptions to industry norms and management guidance.
6Step 5 — Full UFCF Formula Breakdown
Now that we’ve covered each component, let’s assemble the complete UFCF formula exactly how it’s used in real DCF models.
Expanded UFCF Formula (Analyst Format)
EBIT× (1 − Tax Rate)
= NOPAT
+ Depreciation & Amortization
+ Stock-Based Compensation
+ Other Non-Cash Items
− ΔNWC
− CapEx
= Unlevered Free Cash Flow (UFCF)
Condensed Version
UFCF = EBIT × (1 − T) + D&A + Non-Cash Items − ΔNWC − CapExIntuition: What UFCF Actually Represents
UFCF answers a simple question:
“How much cash did this business generate from core operations, ignoring capital structure?”
It’s the cleanest signal of a company's operating strength — unaffected by interest, leverage, or financing decisions.
Start from EBIT and Apply Taxes
EBIT × (1 − T) gets you to NOPAT — after-tax operating income.
This is the full analyst-level UFCF formula in action: start from EBIT, tax it to get NOPAT, add back non-cash items, subtract working capital investment and CapEx.
7Step 6 — Fully Worked UFCF Examples (3 Total)
These examples simulate what you’ll encounter in real modeling tests, investment banking interviews, and your first days as a summer analyst. We’ll start simple and build up to a fully integrated UFCF calculation.
Example 1 — Simple UFCF Calculation
This example teaches the mechanical steps cleanly, without working capital or unusual adjustments.
Given:
Revenue = 400EBIT Margin = 20%
EBIT = 80
Tax Rate = 25%
D&A = 15
CapEx = (25)
ΔNWC = 0
Step-by-step:
+ D&A = 15
− CapEx = (25)
− ΔNWC = 0
UFCF = 60 + 15 − 25 = 50
This structure is the most common layout used in first-round interviews.
Example 2 — UFCF With Working Capital
Now we introduce ΔNWC. This example resembles the format seen in Moelis, Evercore, and Qatalyst technicals.
Given:
Revenue = 550EBIT = 110
Tax Rate = 25%
Depreciation = 22
CapEx = (35)
AR ↑ by 12
Inventory ↑ by 8
AP ↑ by 10
Step-by-step:
+ D&A = 22
ΔNWC = −12 − 8 + 10 = −10 (cash outflow)
− ΔNWC = (−10)
− CapEx = (35)
UFCF = 82.5 + 22 − 10 − 35 = 59.5
This example teaches the most common pitfall: AR and Inventory increases drain cash, while AP increases help cash.
Example 3 — Advanced UFCF With All Components
This example integrates everything: EBIT, taxes, non-cash items, ΔNWC, and CapEx. It resembles a typical modeling test or a condensed first-year analyst assignment.
Given:
Revenue = 900EBIT Margin = 18% → EBIT = 162
Tax Rate = 25%
Depreciation = 40
SBC = 12
CapEx = (55)
AR ↑ by 20
Inventory ↑ by 12
Prepaids ↑ by 3
AP ↑ by 15
Accruals ↑ by 4
Step-by-step:
NOPAT = 162 × (1 − 0.25) = 121.5
2. Add Back Non-Cash Charges
+ Depreciation = 40
+ SBC = 12
Pre-WC Cash Flow = 121.5 + 40 + 12 = 173.5
3. Calculate ΔNWC
ΔNWC = −ΔAR − ΔInv − ΔPrepaids + ΔAP + ΔAccruals
ΔNWC = −20 − 12 − 3 + 15 + 4 = −16
(Cash outflow of 16)
4. Subtract CapEx
CapEx = (55)
UFCF = 173.5 − 16 − 55 = 102.5
This example demonstrates how large working capital or CapEx swings can materially change UFCF even when EBIT looks healthy.
8UFCF in Multi-Year DCF Forecasts
Once you understand one-year UFCF, scaling to multi-year forecasts is mechanical: apply the same formula year after year using projected revenue, margins, CapEx, working capital, and non-cash charges.
What Changes Each Year?
• Revenue grows → EBIT grows → NOPAT grows • D&A typically tied to CapEx → both shift year-to-year • ΔNWC fluctuates based on working capital ratios • CapEx often modeled as a % of revenue or fixed expansion plan
Mini Multi-Year Example (Conceptual)
Year 1 UFCF = 80Year 2 UFCF = 94
Year 3 UFCF = 111
Year 4 UFCF = 128
Year 5 UFCF = 144
9Key Takeaways — UFCF Mastery
• UFCF represents operating cash flow available to all capital providers.
• Always begin with EBIT × (1 − T), not net income.
• Add back all non-cash charges (D&A, SBC, amortization).
• ΔNWC can meaningfully raise or lower UFCF depending on operational intensity.
• CapEx is a true cash outflow and the most important judgment call.
• UFCF should trend logically with revenue, margins, and reinvestment needs.
Analyst-Level Insight
Great forecasters recognize that UFCF is not just math — it's about understanding the company’s economics. How fast must the business reinvest? How do working capital demands scale? What is sustainable CapEx? These questions matter far more than simply plugging numbers into a formula.
10Interview Prep — UFCF Questions
These questions appear frequently in summer analyst and first-year analyst interviews.
1. Walk me through how to calculate UFCF.
2. Why do we start with EBIT instead of net income?
3. What non-cash items get added back in UFCF?
4. How does an increase in AR affect UFCF?
5. Why does CapEx reduce UFCF?
6. What is the difference between UFCF and Levered FCF?
7. How would a decrease in inventory affect UFCF?
8. How does SBC influence UFCF?
9. Why ignore interest expense when calculating UFCF?
10. Explain ΔNWC in simple terms.
11. What is the relationship between PP&E and UFCF?
12. Why do depreciation and CapEx move in opposite directions?
13. How do deferred taxes affect UFCF?
14. What happens to UFCF if AP decreases?
15. How does high growth affect UFCF?
16. What industries have negative UFCF early on?
17. How do you sanity-check UFCF projections?
18. When can UFCF be negative?
19. What happens to UFCF if CapEx doubles unexpectedly?
20. Walk me through a 10-unit shock to inventory.
Practice Drill
Choose a company, pull its last two 10-Ks, and extract: EBIT, D&A, CapEx, and ΔNWC. Then calculate UFCF directly from the filings. This exercise is the fastest way to deepen your intuition and impress interviewers.