Free cash flow yield (FCFY): Discussion, formula, and examples

Cash is king. And for your business to keep growing, it needs cash. Unsurprisingly, executives and investors care deeply about cash flow, and your organization will be expected to report on it effectively.

That makes free cash flow yield (FCFY) one of the most important metrics used to reflect your financial standing. In this article, we’ll break down what it is, how you calculate it, and what kind of FCFY your company should aim for.

What is free cash flow yield (FCFY)?

FCFY is a ratio of cash flow from a business’s core operations relative to the company’s valuation.

This metric is crucial for financial reporting because it reflects an organization’s cash flow compared to its size. FCFY is used as an indicator of financial performance by investors because a strong yield reveals how well a company can meet all of its financial obligations.

Free cash flow (FCF) vs. Free cash flow yield (FCFY)

Put simply, free cash flow is the money a company has left over after paying its expenses. This includes maintaining capital expenditures and operating costs. You may have also heard of the term “5-year free cash flow”. This is, of course, the amount of growth in cash flow a company has made over 5 years.

FCFY takes that free cash flow number and divides it by the organization’s market value.

Unlevered free cash flow yield

Unlevered FCFY is the money a company has before meeting financial obligations. It’s the money dedicated to paying equity and debt holders. This could also be called free cash flow to the firm (FCFF).

Levered free cash flow yield

Levered free cash flow yield is the cash a company has after meeting financial obligations. This is also referred to as free cash flow to equity (FCFE) and represents the money a company has left over to pay shareholders, dividends, or to invest back into the business.

FCFY vs. earnings

Earnings or net income represent a company’s incoming cash, whereas FCFY is a measure of profitability. FCFY will give investors and stakeholders more context for a company’s financial standing.

FCFY vs. valuation multiple

A valuation multiple reports on a company’s implied value based on one specific operating metric. This shows a smaller snapshot of a company’s value, whereas FCFY is a representation of overall performance.

FCFY vs. EBITDA

EBITDA, or earnings before interest, tax, depreciation, and amortization is also a way for a company to measure profitability. However, EBITDA excludes the outflow of cash from a company paying capital investments. Investors tend to use EBITDA to compare profitability between similar companies, but it does give a smaller picture of profitability compared to FCFY.

FCFY vs. other valuation ratios

There are many other valuation ratios used to measure financial performance. Things like price-to-sales, price-to-book, and price-to-earnings are more specific valuation metrics. Price to free cash flow reflects the market price of a single share vs price per share of FCF.

The main differentiator to keep in mind when comparing these other valuation ratios is that FCFY measures free cash flow against the company’s overall valuation. It’s more of a big-picture indicator of financial performance.

Free cash flow yield formula

You can calculate FCFY with this formula:

Free cash flow yield = Free cash flow per share ➗ Market capitalization per share

When completing this calculation, companies choose either an unlevered or levered formula. Here are the differences and why you might choose one over another.

Unlevered FCFY formula & how to calculate

To calculate unlevered FCFY, use the following formula:

Unlevered FCFY = Unlevered cash flow ➗ enterprise value

The unlevered free cash flow on its own would not provide much insight into the financial standing compared to other companies. By dividing it by the enterprise value, it can be benchmarked against your company’s performance history and your competitors.

To execute this calculation, you need to first calculate unlevered cash flow. You can find more on this calculation here.

Levered FCFY formula & how to calculate

For calculating a levered FCFY, use the following formula:

Levered FCFY = Levered cash flow ➗ Equity value

This calculation will show equity holders how much residua free cash flow you could allocate to each unit of equity value. You could alternatively use FCF per share and divide by the current share price as another way to calculate levered FCFY.

To execute the calculation, you need to first calculate for levered cash flow. You can find more on this calculation here.

How to interpret free cash flow yield

Running a simple calculation is one thing, but what does it mean in the context of your company’s financial performance? Here’s a simple breakdown of how you can interpret those cash flow results.

How much FCFY is good?

Of course, the higher the yield the better, as it indicates that a company can easily meet financial obligations and grow. In terms of numbers, a “good” FCFY will vary depending on your industry, and how long your company has been in business. For example, back in September of 2015, Apple had a FCFY of 11.1 %. Compare that to its FCFY of 3.8% back in 2023.

What is a healthy FCFY?

Typically, a healthy FCFY is a positive one. A score high enough to signify that a company can cover operating expenses for one month is considered healthy. To put it in numbers, anywhere between 4% and 7% means a company is generally in a good spot. Anything above 9% or 10% is excellent.

On the flip side, a company with a negative yield would signify to an investor that your company does not have enough cash to meet capital expenditures and operational expenses.

Average free cash flow yield by industry

“Good” yields may differ depending on the industry in which your company operates. But generally, most industries with an average positive yield fall somewhere in that 4% to 7% sweet spot. There are, of course, a few exceptional companies with much higher yields, but the industries vary.

Average free cash flow yield for the S&P 500

The S&P 500 index measures the stock value of 500 of the world’s largest corporations. They calculate a sector-neutral FCFY index, that averages out the yields across the most common industries.

As of July 2023, it had a 9.77% average, and as of July 2024, it’s closer to 6.27%

Factors that affect free cash flow yield

Multiple factors can significantly affect your free cash flow yield:

• Changes in operating efficiency
• Working capital management
• New revenue growth
• Share prices

Since FCFY depends on your cash flow, your capital expenditures and your organization’s value on the market, any changes in these factors will have the most impact on your FCFY.

Liability-adjusted cash flow yield (LACFY)

LACFY is another variation, although not commonly used. This calculation involved taking a company’s long-term FCF and dividing it by its liabilities over the same time. Investors and other stakeholders would want to consider this number to determine how a company is valued or how long it will take for the buyout to be profitable.

Free cash flow yield examples

Let’s go over a few examples of what FCFY might look like in practice. For each example, we’ll use the same fictitious company, Company A.

Free cash flow yield calculation example (FCFY)

Say Company A’s cash flow from operating activities was $150,000 in the last period. They also spent $20,000 during that period on capital expenditure for new inventory.

Company A’s outstanding shares trade at $15.00 per share, and they have 90,000 outstanding shares.

First, we’ll calculate FCF by subtracting CapEx from operating cash flow.

FCF = $150,000 - $20,000.

FCF = $130,000.

Now, we’ll calculate the FCF per share by dividing outstanding shares by FCF.

FCF per share = $130,000 ➗ 90,000

So, FCF per share = $1.44

Finally, to calculate the FCFY we use the FCF per share price divided by the current price per share.

FCFY = $1.44 ➗ $15.00

FCFY = 9.6%

This is a great yield for Company A. This means that for every $1 someone invests in a share, there is $0.096 generated in FCF.

Unlevered free cash flow yield calculation example (FCFF)

The same company, Company A, has generated $2 million in EBIT for this past fiscal year.

We need to calculate the unlevered FCF first, by identifying the net operating profit after taxes (NOPAT).

Say there’s a 30% tax on the $2 million in EBIT, making our NOPAT $1.4 million.

Next, we need to add back depreciation and amortization (D&A) as it is a non-cash expense. Our D&A is $500,000, bringing our number back up to $1.9 million.

Finally, we subtract the capital expenditures ($200,000) and changes in net working capital ($150,000). This brings our final unlevered FCF to $1,550,000.

Now we can calculate unlevered FCFY by taking our $1,550,000 and dividing it by our enterprise value. In this example, the enterprise value is $16,000,000.

Unlevered FCFY = $1,550,000 ➗ $16,000,000

Unlevered FCFY = 9.6%

Levered free cash flow yield calculation example (FCFE)

Moving along using the same numbers as example 2, we must now calculate the levered FCF from our unlevered FCF number ($1,550,000).

From our unlevered FCF number, we’ll deduct three items of debt: We have a mandatory debt paydown, our tax shield of interest, and our interest expense. In this example:

Mandatory debt paydown = $500,000

Tax shield of interest = $100,000 (this is shown as an inflow, as tax savings benefit capital providers)

Interest expense = $175,000

After these three line items, our final levered FCF total comes to $775,000

Now to calculate levered FCFY we take our $775,000 and divide it by equity value. The equity value in this example is $12,800,000.

Levered FCFY = $775,000 ➗ 12,800,000

Levered FCFY = 6.1%

Unlevered vs. levered FCFY calculation example

The difference between our unlevered and levered FCFY examples is the levered FCFY is impacted by Company A’s debt obligations.

Unlevered FCFY = 9.6%

Levered FCFY = 7.6%

Difference = 2%

If Company A had no debt obligations, there would be no difference between the unlevered and levered FCFYs. It’s important to record the differences on your balance sheet if your company does have debt obligations like Company A, to get a more detailed picture of financial performance.

Liability-adjusted cash flow yield calculation example

Liability-adjusted cash flow yield (LACFY) is a ratio that is often used to compare companies within similar industries but is not often used in company valuation.

An analyst will often compare 10 years of LACFY data with a 10-year treasury note. The smaller the discrepancy between LACFY and the treasury note is, the less appealing an investment will be. You can calculate LACFY with the following example:

LACFY = Average FCF [(Outstanding Shares + Warrants + Options) x (Per Share Price) - Liabilities] - [Assets - Inventory]

Why free cash flow yield matters to investors (and why that matters to CFOs)

Investors can compare your FCFY with industry benchmarks, and against competitors in your industry. This is because the calculation shows them how much FCF your company is generating for every dollar they choose to invest.

This gives the investor more insight into the ROI they could expect by investing in your company.

This matters to CFOs because a high yield reflects positively on the company, indicating that the shares are undervalued, and the business is in positive financial standing. A demonstrably strong yield could be make-or-break when bridging the gap between business and investor.

Free cash flow yield FAQs

What does a high cash flow yield mean?

A high cash flow yield means a business is generating enough money to meet financial obligations. It’s a clear indicator of financial standing, and whether a company is profitable or on its way to it.

How do you calculate unlevered free cash flow?

To calculate unlevered FCF, use the following formula:

Unlevered FCF = Non-operating profit after tax + depreciation and amortization - increase in net working capital - capital expenditures

From there, if you’d like to calculate the unlevered FCFY, you will take the calculation from this formula and divide it by enterprise value.

How do you calculate levered free cash flow?

To calculate levered FCF, use the following formula:

Levered FCF = Net income + depreciation and amortization - change in net working capital - capital expenditures + net borrowing

If you want to calculate levered FCFY, you will take the resulting number from this calculation and divide it by equity yield.

How do you calculate cash flow yield ratio?

To calculate cash flow yield ratio, take your current free cash flow per share number and divide it by the current share price.

What is the FCF ratio?

The FCF ratio compares free cash flow to operating cash flow. The higher the FCF ratio, the more flexibility a business has to pay debts, invest back in the business, or pay dividends. This shows investors and stakeholders how much value your business has.

Conclusion: Let cash flow with Prophix One™

To summarize, free cash flow yield is a measure of how much money your business has left over after meeting its financial obligations.

This, of course, is crucial for investors. This calculation will make it easier to compare your business to industry benchmarks and competitors. A high yield looks great to those looking to establish a partnership with you.

When it comes to calculating free cash flow yield, determine whether you’re looking to do a levered or unlevered calculation. This process and calculation can be streamlined if your team uses a financial performance platform, like Prophix One.

Watch our 2-minute video to see how Prophix One can simplify your cash flow management.