Cash Flow vs. EBITDA: What’s the Difference?

Cash Flow vs. EBITDA: An Overview

Analysts use several 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 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
• It often refers to operating cash flow (OCF).
• Cash flow and specifically OCF are 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 which are both included in operating cash flow.
• Both EBITDA and OCF add back depreciation and amortization.

Cash Flow

Cash flow is the inflow and outflow of cash within a company. The cash flow statement presents the company’s cash flows. 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’s calculated by adding depreciation and amortization back to net income as well as changes in accounts payable and receivable.

Important

GAAP allows the presentation of operating cash flow in two ways: 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 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 such as depreciation and amortization and the financing aspect such as interest, and taxes. It’s often used as a measure of a company’s ability to service debt.

The basic EBITDA formula is operating income plus depreciation and amortization. The more expanded formula for EBITDA is net income plus interest plus taxes plus depreciation and amortization. GAAP doesn’t recognize EBITDA as a measure of financial performance. It’s still widely used in valuations and debt servicing analyses regardless.

EBITDA aims to establish the amount of cash a company can generate before accounting for any additional assets or expenses that aren’t related to the primary business operations.

What Is Operating Income?

Operating income is what remains after direct and indirect costs of operation have been subtracted from sales revenue. The calculation doesn’t include interest expenses, interest income, or any other income that’s not associated with operations.

What Is GAAP?

Generally accepted accounting principles are referred to as GAAP. They were established by the Government Accounting Standards Board (GASB) and the Financial Accounting Standards Board (FASB) to provide a standardized set of accounting rules and procedures to govern the measurement, presentation, recognition, and disclosure of a firm’s financial data. All public companies must follow GAAP guidelines.

How Does Depreciation Work in Accounting?

Depreciation is the accounting process of dividing the cost of an acquired asset throughout its useful life rather than claiming it all at once. It’s arrived at by subtracting an asset’s salvage value from its initial cost at the time of purchase and then dividing the resulting number by the years of the asset’s useful life. Depreciation is a critical component of taxation.

The Bottom Line

Operating cash flow tracks the cash flow generated by a business’s operations, ignoring cash flow from investing or financing activities. EBITDA is much the same except it doesn’t factor in interest or taxes which are both factored into operating cash flow because they’re 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.

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