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
EBITDA offers a view of a company's operational profitability before the impact of financial decisions, tax environment, and accounting practices. Cash flow reflects the actual amount of cash being generated and used by the business, crucial for understanding liquidity and operational efficiency.
Are EBITDA and cash flow the same? ›
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).
What is the difference between Ebita and operating cash flow? ›
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 go 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.
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.
Can you have positive EBITDA and negative cash flow? ›
If a company has significant debt and high-interest payments, it could be profitable at the operational level (positive EBITDA) but still have negative FCF due to the cash outflows required to service its debt.
What is cashflow? ›
Cash flow is the net cash and cash equivalents transferred in and out of a company. Cash received represents inflows, while money spent represents outflows. A company creates value for shareholders through its ability to generate positive cash flows and maximize long-term free cash flow (FCF).
Is cash flow the same as profit? ›
Profit is defined as revenue less expenses. It may also be referred to as net income. Cash flow refers to the inflows and outflows of cash for a particular business. Positive cash flow occurs when there's more money coming in at any given time, while negative cash flow means there's more money out.
What is the formula for cash flow? ›
You'll find this information in your financial statement. Operating Cash Flow = Operating Income + Depreciation – Taxes + Change in Working Capital.
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.
EBITDA removes the impact of income taxes. The idea is that this makes firms easier to compare since two companies may have differing tax rates due to legal structure (e.g. C corporation tax payer vs. S corporation or limited liability company tax payer) or geography.
Is EBITDA gross profit? ›
Cost Inclusions: Gross profit only considers direct production costs, such as raw materials and direct labour, while EBITDA accounts for all operating expenses, including indirect costs like administrative and marketing costs.
What is the difference between cash flow and net income? ›
Net Income is the result of revenues minus the expenses, taxes, and costs of goods sold (COGS). Operating cash flow is the cash generated from operations, or revenues, less operating expenses. Many investors and analysts prefer using operating cash flow as an indicator of a company's health.
What does Warren Buffett use instead of EBITDA? ›
Eventually, he was forced to close the business because he couldn't generate enough cash. That's why when Warren Buffett looks at companies, he gauges their value on their free cash flow, not their EBITDA. He wants to know whether there will be any cash in the black box at the end of the year.
What's the difference between EBITDA and 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 is EBITDA misleading? ›
EBITDA is an oft-used measure of the value of a business. But critics of this value often point out that it is a dangerous and misleading number because it is often confused with cash flow. However, this number can actually help investors create an apples-to-apples comparison, without leaving a bitter aftertaste.
What is the difference between EBITDA and FFO? ›
Both FFO and EBITDA are used as an alternative to net income, and both add back depreciation and amortization to net income. The main difference between FFO vs EBITDA is that FFO looks at free cash flow from operations, while EBITDA seeks to measure profitability from operations.
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.
