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
Cash flow considers all revenue expenses entering and exiting the business (cash flowing in and out). EBITDA is similar, but it doesn't take into account interest, taxes, depreciation, or amortization (hence the name: Earnings Before Interest, Taxes, Depreciation, and Amortization).
What is the difference between cash flow and EBITDA? ›
While EBITDA helps ascertain a company's earning potential, cash flow shows how a company's earnings are actually being used, indicating available money for owners and business needs.
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.
What is more important earnings or cash flow? ›
There are a couple of reasons why cash flows are a better indicator of a company's financial health. Profit figures are easier to manipulate because they include non-cash line items such as depreciation ex- penses or goodwill write-offs.
What does EBITDA not include? ›
EBITDA is a company's net income but excludes the impact of interest income or expense related to debt instruments, depreciation and amortization, and stated and federal income taxes.
Should EBITDA be 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.
Is EBITDA or cash flow more important? ›
EBITDA sometimes serves as a better measure for the purposes of comparing the performance of different companies. Free cash flow is unencumbered and may better represent a company's real valuation.
What is cash flow in simple terms? ›
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.
What are the 3 types of cash flows? ›
There are three cash flow types that companies should track and analyze to determine the liquidity and solvency of the business: cash flow from operating activities, cash flow from investing activities and cash flow from financing activities. All three are included on a company's cash flow statement.
How can you be cash flow positive but not profitable? ›
Sometimes, a business can be cash-flow positive but may not be profitable For instance, if a business operates at a net loss, borrowing cash helps create a positive cash flow. Similarly, when it sells a significant asset to raise capital, the money it receives is an inflow of cash.
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.
Why Buffett doesn t like EBITDA? ›
Buffett's statement emphasizes that depreciation, a non-cash expense, is an inevitable cost of doing business, essentially representing the wear and tear of assets. By excluding depreciation, EBITDA can lead to a misleadingly optimistic portrayal of a company's financial health.
What does EBITDA really tell you? ›
EBITDA indicates how well the company is managing its day-to-day operations, including its core expenses such as the cost of goods sold.
How is EBITDA used for cash flow? ›
It is a measure of a company's operating profit, or how much money it makes from its core business activities. EBITDA is often used as a proxy for cash flow, but it is not the same thing. EBITDA does not account for the cash inflows and outflows that affect a company's liquidity and solvency.
Is EBITDA on the cash flow statement? ›
It is often claimed to be a proxy for cash flow, and that may be true for a mature business with little to no capital expenditures. EBITDA can be easily calculated off the income statement (unless depreciation and amortization are not shown as a line item, in which case it can be found on the cash flow statement).
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.
How do you calculate EBITDA from cash flow statement? ›
To calculate EBITDA, start with Operating Income or EBIT on the Income Statement and then add the Depreciation & Amortization (D&A) from the Cash Flow Statement. You add back D&A because it represents the allocation of spending on long-term assets (factories, buildings, IP, etc.) from previous periods.
