What is the first step in moving from revenue to unlevered free cash flow in a DCF?

The first step in moving from revenue to unlevered free cash flow in a DCF is to calculate EBIT (Earnings Before Interest and Taxes) or the operating margin. This step is crucial because unlevered free cash flow focuses on the cash generated by the company's operations before any financing effects or tax impacts.

To derive unlevered free cash flow, you start the conversion process with revenue, moving through a series of operational metrics. After arriving at EBIT, you can subsequently adjust for additional items like taxes, depreciation, and changes in working capital to arrive at the unlevered free cash flow. By calculating EBIT first, you establish a clear picture of the company's profitability from its core operations, which is essential for accurate cash flow projections.

This step is foundational, as it helps provide insights into the operational efficiency and financial health of the business, serving as a bridge to further adjustments that lead to the final calculation of free cash flow.