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EBITDA vs Cash Flow

EBITDA is a profit measure with four things deliberately added back: interest, tax, depreciation and amortisation. Cash flow is what actually arrived in the bank. Between the two sit the payments EBITDA excludes and the working capital it ignores, which is why a company can report record EBITDA and still run out of money.

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The add-backs are not dishonest, they are a specific view. Removing depreciation and amortisation is meant to approximate the cash earnings of operations before the cost of the assets that produce them. The trouble is that those assets eventually have to be replaced, and the replacement appears as capital expenditure, which EBITDA never sees.

Working capital is the other gap. Growing revenue usually means carrying more receivables and more inventory, and both consume cash even when every sale is profitable. A company growing 30% a year can have strong EBITDA and negative operating cash flow for exactly that reason.

Read together, the two numbers describe a conversion rate. EBITDA says how much the operation earns before financing and accounting; free cash flow says how much is left to repay debt, pay dividends or reinvest. The ratio between them is one of the fastest ways to see whether reported profit is turning into money.

EBITDA

How To Calculate EBITDA

EBITDA strips out financing costs, tax and the two big non-cash charges to show what the operating business actually earned.

Cash flow

How To Calculate Cash Flow

Cash flow is net income restated as cash, which means adding back non-cash charges and adjusting for working capital.

How They Differ

EBITDA compared with Cash flow
AttributeEBITDACash flow
What it measuresOperating profit before interest, tax and depreciationMoney that actually moved
Starting pointRevenue minus operating costsNet profit, adjusted back to cash
Interest and taxAdded backDeducted
DepreciationAdded backAdded back, but capital spending is deducted
Working capitalIgnoredCounted
Capital expenditureIgnoredDeducted for free cash flow
Can be positive while the bank balance fallsYesNo — that is the point of it
Who leans on itLenders and acquirers pricing a businessAnyone who has to pay a bill

The Same Numbers, Both Ways

A business with $200,000 of EBITDA, $25,000 of interest, $30,000 of tax, a $40,000 working capital increase and $60,000 of capital spending.

EBITDA
$200,000
Interest
$25,000
Tax
$30,000
Working capital increase
$40,000
Capital expenditure
$60,000
Worked example: EBITDA versus Cash flow
LineEBITDACash flow
EBITDA$200,000$200,000
InterestAdded back-$25,000
TaxAdded back-$30,000
Working capitalIgnored-$40,000
Operating cash flowNot reported$105,000
Capital expenditureIgnored-$60,000
Free cash flowNot reported$45,000
Share of EBITDA100.0%22.5%

EBITDA of $200,000 becomes $105,000 of operating cash flow once $25,000 of interest, $30,000 of tax and $40,000 of working capital are paid, and $45,000 of free cash flow after $60,000 of capital spending. That is 22.5% of the headline figure — $155,000 of it never reached the bank.

When To Use Each

EBITDA

  • You are valuing a business, where a capital-structure-neutral earnings figure is the conventional starting point.
  • You are comparing companies with very different debt levels or tax positions.
  • You want to see operating performance before the accounting for past asset purchases.

Cash flow

  • You need to know whether the business can service debt or pay a dividend this quarter.
  • You are checking whether reported profit is turning into money as revenue grows.
  • You are lending, where repayment comes from cash rather than from EBITDA.

Common Questions

Why is EBITDA criticised so heavily?

Because it excludes real costs. Depreciation is the accounting record of assets wearing out, and replacing them is a genuine cash outflow. Charlie Munger's line — that EBITDA is earnings before the bad stuff — is a fair summary of the objection.

Which cash flow figure should I use?

Operating cash flow for judging the core business, free cash flow for judging what is left for investors and lenders. Free cash flow is the stricter measure because it charges the business for the capital it consumes.

Can EBITDA be negative while cash flow is positive?

Yes, in unusual cases. A company with heavy depreciation and a large release of working capital can generate cash in a year when EBITDA is negative. It is a warning sign rather than a comfort: releasing working capital only works once.

Does a high EBITDA margin mean a healthy business?

It means the operating economics work before capital intensity. A telecom or a utility can have excellent EBITDA margins and thin free cash flow because the assets are expensive. Comparing EBITDA margins across industries with different capital needs is a common error.

How do I reconcile the two?

Start at EBITDA, subtract interest, tax and the increase in working capital to reach operating cash flow, then subtract capital expenditure to reach free cash flow. Every line should be traceable to the cash flow statement, and if it is not, the reconciliation is wrong.

More Comparisons

  • Depreciation vs Amortization

    A $36,000 asset with $6,000 of salvage depreciates $6,000 a year for five years. A $36,000 loan at 6% amortizes for $695.98 a month, $41,758.85 in total. One writes down an asset, the other pays down a debt.

  • Gross Margin vs Profit Margin

    On $250,000 of revenue with $150,000 of product cost and $60,000 of overhead, gross margin is 40.0% and net margin is 10.8%. The 29-point gap is everything the business spends between making the product and keeping the money.

  • Break-Even vs Payback Period

    With $120,000 of fixed costs and $16 of contribution per unit, break-even is 7,500 units a year. The $300,000 machine behind them takes 7.5 years to repay at 10,000 units. Break-even asks how much you must sell, payback asks how long you wait.

All comparisons →

Sources

Both methods sit in Business.