EBITDA is a metric that helps business owners and their professional advisers to compare a company’s profitability against other similar businesses, and is often used when valuing a business for sale.
Sometimes the metric is viewed synonymously with cash flow but in reality there’s considerable difference between the two, in both calculation and the implications behind the results.
So what are the main differences between cash flow and EBITDA, and when would a business use them?
What is EBITDA?
EBITDA is an acronym that stands for Earnings Before Interest, Tax, Depreciation, and Amortisation. It’s been widely used in business since the 1980s, and indicates a company’s capability to generate cash without certain liabilities and expenses affecting the results.
Interest, tax, depreciation, and amortisation, are all removed from the earnings figure leaving a pared down view of profitability and cash generation, with items removed that aren’t directly associated with operational activity.
What is cash flow?
Cash flow analysis incorporates all monies going into and out of a company’s books, including interest, tax, depreciation, and amortisation. Capital spending is accounted for, and because nothing is omitted it offers a more comprehensive picture of business financial health overall.
This inclusion of working capital is particularly relevant for asset-rich businesses, or those that are highly leveraged, as depreciation, amortisation, and loan interest, are all essential and significant expenses that affect a company’s liquidity and financial wellbeing.