EBITDA and cash flow: What sets them apart?

Business Journals

3 days ago

EBITDA is often used and confused as an approximation of cash flow. Many business professionals (CPAs, business owners, bankers, attorneys and others) struggle to understand the differences between EBITDA and cash flow from operations within a business. Below are some differences between these business metrics.
Definitions of EBITDA and operating cash flow
EBITDA is defined as net income (earnings) with interest, taxes, depreciation and amortization added back to it. EBITDA can be used to analyze and compare the profitability between companies and industries because it eliminates the effects of financing and accounting decisions.
Operating cash flow or OCF is (in accounting) a measure of the amount of cash generated by a company's normal business activities. Operating cash flow is important because it indicates whether a company generated sufficient positive cash flow to maintain and grow its operations or whether it may require external financing. OCF is calculated by adjusting net income for non-cash items such as depreciation and also changes to working capital balances such as accounts receivable, inventory and account payable. The operating cash flow statement is typically included in the U.S. GAAP based financial statements and sometimes referred to as the 'indirect direct' method of cash flows.
The table below compares EBITDA to OCF. A third column is presented for discussion purposes.
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Courtesy of Meaden & Moore
A few comments about the table and EBITDA
EBITDA is widely used and is easy to calculate by taking income from operations (reported on the income statement before interest and taxes) and adding back depreciation and amortization (reported as a line item or items in the cash flow statement).
EBITDA is used almost everywhere, from valuation multiples to bank covenant calculations in credit agreements.
EBITDA allows you to compare the profitability of different companies by cancelling the effects of a company's capital, financing and tax entity structure. It is the standard metric in the business community.
But keep in mind the EBITDA does not equal cash flow. The most obvious shortfalls of the EBITDA calculation as a measure of cash flow are that EBITDA does not
Consider the increase (or decreases) in working capital accounts that may fluctuate with a business as it grows (shrinks)
It does not subtract capital expenditures that are needed to support production, especially in a manufacturing environment.
In the table above, operating cash flow (OCF) does a better job of adjusting for the increasing working capital needs of a growing company. But OCF fails to add back interest expense and income tax expense. Adding back these items make it easier to compare businesses with different capital or tax structures.
As presented in column 3, I would argue that we should also include capital expenditures in the evaluation of the operations of a company. Capital expenditures are necessary to support and grow production. Capital expenditures may have a significant impact on cash flow if the business has a need for expanded capacity or updates to its equipment.
EBITDA is, and will probably always be, the key business metric for evaluating the performance of a business. However, keep in mind that EBITDA is not cash flow and that many other factors should be considered.
Contact us today to learn more about differences between EBITDA and cash flow.
Meaden & Moore provides client focused accounting, tax, forensic and business advisory services to businesses and individuals in a wide array of industries. With over 250 professionals across multiple offices in the U.S., Canada, and the U.K., the team has the knowledge, passion, and expertise to help clients thrive.
John Nicklas, CPA, has more than 25 years of experience serving the accounting and business advisory needs of middle-market companies. His experience includes compiling and analyzing detailed reports on financial performance, comprehensive reviews of internal control, and developing audit and review procedures for closely held businesses in a wide variety of industries.