Cash Flow vs. EBITDA: An Overview
Analysts use a number of metrics to determine the profitability or liquidity of a company. Earnings before interest, taxes, depreciation, and amortization (EBITDA) is often used as a synonym for cash flow, but in reality, they differ in important ways.
Key Takeaways
- Cash flow is a broad term that generally refers to the cash coming into and going out of a company—often mean to represent operating cash flow (OCF).
- Cash flow, specifically OCF, is meant to determine how a company's core operations are performing.
- Earnings before interest, taxes, depreciation, and amortization (EBITDA) is another measure of a company's operations.
- EBITDA doesn't factor in interest or taxes, both of which are included in operating cash flow (as they are cash outflows).
- Both EBITDA and OCF add back depreciation and amortization.
Cash Flow
Cash flow, broadly, is the inflow and outflows of cash within a company. The cash flow statement presents the company's cash flows. More specifically, cash flow often refers to operating cash flow (OCF).
Operating cash flow is a figure defined under the generally accepted accounting principles (GAAP) where it is calculated by adding depreciation and amortization back to net income, as well as changes in accounts payable and receivable. There are two ways that GAAP allows the presentation of operating cash flow—direct and indirect.
EBITDA
EBITDA became popular in the 1980s with the rise of the leveraged buyout industry. It was used to establish a company's operating profitability relative to companies with similar business models with no consideration given to their capital structure or in other words their use of debt or equity as their source of capital.
EBITDA looks to measure only the operations of a company. It removes the major non-cash charges (depreciation and amortization), the financing aspect (interest), and taxes. It is often used as a measure of a company's ability to service debt.
The basic EBITDA formula is operating income plus depreciation and amortization. Or, the more expanded formula for EBITDA is net income plus interest plus taxes plus depreciation and amortization. However, GAAP does not recognize EBITDA as a measure of financial performance. Regardless, it is still widely used in valuations and debt servicing analyses.
EBITDA aims to establish the amount of cash a company can generate before accounting for any additional assets or expenses not directly related to the primary business operations
Key Differences
Operating cash flow tracks the cash flow generated by a business' operations, ignoring cash flow from investing or financing activities. EBITDA is much the same, except it doesn't factor in interest or taxes (both of which are factored into operating cash flow given they are cash expenses). Both EBITDA and OCF add back depreciation and amortization. Overall, both look to determine how well a business is generating money from its core operations.
FAQs
Key Differences
How does EBITDA differ from cash flow? ›
Cash flow accounts for changes in working capital, reflecting real cash movement. EBITDA, however, does not factor in these changes, focusing solely on earnings before interest, taxes, depreciation, and amortization.
Why free cash flow is better than EBITDA? ›
FCF, unlike EBITDA, directly focuses on the actual cash generated by a company's operations. It considers not only operating profitability, but also capital expenditures and changes in working capital, which are essential for understanding a company's cash-generating ability.
How do you calculate EBITDA from cash flow? ›
The formula for calculating EBITDA is: EBITDA = Operating Income + Depreciation + Amortization. You can find this figures on a company's income statement, cash flow statement, and balance sheet.
What is the difference between operating cash flow and EBIT? ›
Operating cash flow is the money a business generates from its core operations. Net operating income is generally the same as operating income for a company. Operating income is often referred to as earnings before interest and taxes (EBIT), although the two may differ at times.
How do you walk from EBITDA to cash flow? ›
You can calculate FCFE from EBITDA by subtracting interest, taxes, change in net working capital, and capital expenditures – and then add net borrowing. Free Cash Flow to Equity (FCFE) is the amount of cash generated by a company that can be potentially distributed to the company's shareholders.
What is the cash flow to EBITDA ratio? ›
Calculating the FCF conversion ratio comprises dividing free cash flow (FCF) by a measure of operating profitability, most often EBITDA (or EBIT). In theory, EBITDA functions as a rough proxy for a company's operating cash flow, albeit the metric receives much scrutiny among practitioners.
Is EBITDA the same as gross profit? ›
Gross profit appears on a company's income statement and is the profit a company makes after subtracting the costs associated with making its products or providing its services. EBITDA is a measure of a company's profitability that shows earnings before interest, taxes, depreciation, and amortization.
How to calculate cash flow? ›
Free Cash Flow = Net income + Depreciation/Amortization – Change in Working Capital – Capital Expenditure. Operating Cash Flow = Operating Income + Depreciation – Taxes + Change in Working Capital. Cash Flow Forecast = Beginning Cash + Projected Inflows – Projected Outflows = Ending Cash.
Why is cash flow better than profit? ›
Cash flow statements, on the other hand, provide a more straightforward report of the cash available. In other words, a company can appear profitable “on paper” but not have enough actual cash to replenish its inventory or pay its immediate operating expenses such as lease and utilities.
EBITDA stands for Earnings Before Interest, Taxes, Depreciation, and Amortization. It is a financial metric used to measure a company's operational performance and profitability by excluding non-operating expenses and accounting factors.
Why is EBITDA not a good proxy for cash flow? ›
Another limitation of EBITDA is that it does not consider a company's debt levels. A company with high debt levels might have lower cash flows than a company with lower debt levels, even with the same EBITDA.
Does EBITDA include salaries? ›
Ebitda includes all revenue generated by the business minus any expenses related to production such as cost of goods sold, operating expenses like wages and salaries, research and development costs and other overhead expenses.
Is EBITDA usually lower or higher than cash flow? ›
Free cash flow can be higher or lower than EBITDA. In each case, it depends on the circ*mstances in the company, which expenditures were made. If the changes in working capital within a financial year are strongly positive because e.g. a large investment was made, the free cash flow can be less than EBITDA.
What does OCF to EBITDA mean? ›
OCF stands for operating cash flow, which is the cash generated from your core business activities. EBITDA stands for earnings before interest, taxes, depreciation, and amortization, which is a measure of your operating performance without accounting for financing and capital costs.
What is the EBITDA margin formula? ›
EBITDA margin indicates the company's overall health and denotes its profitability. The formula for EBITDA margin is = EBITDA/total revenue (R) x 100.
How is EBITDA different from operating income? ›
Yes, Operating Income vs. EBITDA indicates the profit made by the company. EBITDA shows the profit, including interest, tax, depreciation, and amortization. But operating income tells the profit after taking out the operating expenses like depreciation and amortization.
Is discounted cash flow the same as EBITDA multiple? ›
Both methods determine the value of a business by calculating a present value of expected future cash flows. But where the EBITDA Multiple is primarily concerned with relative value across comparable transactions, DCF focuses on understanding the intrinsic value of a specific business.
How are EBITDA and net profit different? ›
EBITDA is an indicator that calculates the profit of the company before paying the expenses, taxes, depreciation, and amortization. On the other hand, net income is an indicator that calculates the total earnings of the company after paying the expenses, taxes, depreciation, and amortization.
Is EBITDA a good measure of profitability? ›
Generally accepted accounting principles (GAAP) do not include EBITDA as a profitability measure, and EBITDA loses explanatory value by omitting important expenses. Investors must consider net income, cash flow metrics, and financial strength to develop a sufficient understanding of fundamentals.
