Is EBITDA the same as cash flow?
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).
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).
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, Adjusted EBITDA, and Operating Income do not consider working capital needs and capital investments and may give a false sense of profitability if shown without Free Cash Flow. As a reminder, Free Cash Flow is the sum of Operating Cash Flow and Cash Flow for Capital Investments.
The starting point for the cash flow statement is the EBIT computed in the profit and loss statement. To calculate the cash flow, the EBIT is reduced by the taxes paid, decreased by the net working capital (WC), and capital expenditure (CAPEX).
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.
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.
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.
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.
This means that a company with a strong EBITDA might not necessarily have strong cash flows. This is often the case in certain industries that require a substantial amount of capital expenditure (e.g., manufacturing), resulting in higher depreciation expenses and driving EBITDA and cash flow further apart.
Why is EBITDA misleading?
Inaccurate Representation of Cash Flow: EBITDA overlooks changes in working capital, meaning it can inflate cash flow if a business has substantial growth in receivables or inventory.
FCFF can also be calculated from EBIT or EBITDA: FCFF = EBIT(1 – Tax rate) + Dep – FCInv – WCInv. FCFF = EBITDA(1 – Tax rate) + Dep(Tax rate) – FCInv – WCInv. FCFE can then be found by using FCFE = FCFF – Int(1 – Tax rate) + Net borrowing.
If the current owner is not paid a salary, then an appropriate market rate salary is deducted when calculating EBITDA. The same is true if the current owner or manager is underpaid. A market-rate salary for a manager or CEO is deducted to arrive at EBITDA.
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).
Some investors prefer to use FCF or FCF per share rather than earnings or earnings per share (EPS) as a measure of profitability because the latter metrics remove non-cash items from the income statement.
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.
EBITDA is often used when comparing the performance of two different companies of various sizes. Since it casts aside costs such as taxes, interest, amortization, and depreciation, it can yield a clearer picture of the money-generating performance of the two businesses compared to net income.
Since EBITDA shows income before non-cash expenses (expenses like depreciation and amortization that are recorded on an income statement without any cash changing hands), it's a better indicator than net income of a business's ability to bring in cash.
When businesses are analyzed as an investment, EBITDA is considered to more accurately reflect the performance of a business. By reducing the noise created by accounting policies, tax strategies, and capital structure, it provides a more clear idea of the ability of a business to generate profit.
The cash burn rate indicates how quickly a company uses up its cash reserves within a certain period of time. It is therefore a measure of negative cash flow.
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.
EBITDA does not appear on income statements but can be calculated using income statements. Gross profit does appear on a company's income statement. EBITDA is useful in analysing and comparing profitability. Gross profit is useful in understanding how companies generate profit from the direct costs of producing goods.
It is a measure of profitability. The benefit of EBITDA is that it focuses on a company's core performance rather than the effects of non-core financial expenses. The main drawback of EBITDA is that financial expenses can make a great difference to a company's financial health, thus creating a misleading impression.
The info for calculating EBITDA can be easily found on balance sheets and income statements.
A good EBITDA margin is relative because it depends on the company's industry, but generally an EBITDA margin of 10% or more is considered good. Naturally, a higher margin implies lower operating expenses relative to total revenue, while a low or below-average margin indicates problems with cash flow and profitability.
