What is EV/FCF?
The EV/FCF valuation multiple is a ratio comparing a company’s enterprise value (EV) to its free cash flow to firm (FCFF).
How to Calculate EV/FCF (Step-by-Step)
The EV/FCF multiple is the ratio between enterprise value and free cash flow.
- Enterprise Value (EV): The enterprise value measures the value of a company’s operations from the perspective of all capital providers, such as debt lenders, common shareholders, and preferred stockholders.
- Free Cash Flow (FCF): Since the numerator is enterprise value, an unlevered metric, the free cash flow to firm (FCFF) is the appropriate metric to use. FCFF, or “unlevered free cash flow,” is the FCF generated by a company’s core operations that belongs to all stakeholders.
To ensure consistency in the valuation multiple – with respect to the group(s) of capital providers represented – it is necessary for the cash flow metric to be free cash flow to firm (FCFF). Otherwise, there is a mismatch in stakeholder representation in the numerator and denominator.
For instance, the free cash flow to equity (FCFE) metric reflects the cash flows attributable to only equity holders, i.e. post-interest and mandatory debt repayments.
Thus, the corresponding measure of value in the numerator should be equity value (or “market cap”), instead of enterprise value.
EV/FCF Formula
The formula to calculate the EV/FCF multiple is as follows.
The two inputs are calculated using the following formulas.
How to Interpret Enterprise Value to Free Cash Flow Ratio
The EV/FCF multiple answers the question, “For each dollar of unlevered free cash flow (FCFF) generated by a company, how much are investors currently willing to pay?”
Thus, the higher the EV/FCF ratio, the greater the premium attached to a dollar of a company’s unlevered free cash flow (and vice versa).
However, the downside to using the EV/FCF multiple is that a company’s free cash flow to firm (FCFF) tends to fluctuate substantially over time.
Based on the timing of certain events, such as periodic capital expenditures and cyclicality (or seasonality) in working capital levels, the EV/FCF multiple can become distorted. In effect, the ratio tends to be less practical for comparisons, which is the core premise of relative valuation.
Furthermore, the calculation of free cash flow to firm (FCFF) contains more discretionary decisions with less standardization among practitioners, even more so than non-GAAP metrics like EBITDA (and adjusted EBITDA).
For that reason, valuation multiples such as EV/EBITDA and EV/EBIT are far more prevalent in usage.
EV/FCF vs. Unlevered FCF Yield
The EV/FCF valuation multiple is the inverse of the unlevered FCF yield metric.
The unlevered FCF yield metric reflects the cash remaining that is attributable to all providers of capital (e.g. debt and equity), expressed in percentage form.
