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EBITDA vs free cash flow

EBITDA is EBIT plus depreciation and amortisation. Unlevered free cash flow is NOPAT plus D&A, minus capex, minus the increase in working capital. On the teaching sheet EBITDA is $120,000,000 and free cash flow is $55,000,000. One has not paid tax, capex or working capital. The other has.

 EBITDAUnlevered free cash flow
Teaching sheetEBIT $100,000,000 plus D&A $20,000,000 is EBITDA of $120,000,000.NOPAT $75,000,000 plus D&A, minus capex $30,000,000, minus a $10,000,000 working-capital increase, is FCF of $55,000,000.
TaxNot paid. The T in the name is the point.Paid on EBIT as if there were no interest: $25,000,000 on this sheet, leaving NOPAT of $75,000,000.
CapexNot paid. Depreciation was added back and the cash spending was never taken off.Taken off. Raise capex to $50,000,000 and FCF falls to $35,000,000. EBITDA does not move.
Working capitalNot in the figure.In the figure. A $5,000,000 release lifts FCF to $70,000,000. Stock can only be run down once.
What it is forA quick look at operating profit before accounting charges, often the denominator of an EV multiple.The flow a firm DCF discounts. It is what the operations can hand to all funders.
What it is notCash. EBITDA has not paid tax, capex or working capital.Levered cash to equity. Interest and debt principal sit outside unlevered FCF.
On this page

The bridge that EBITDA skips

Start with EBIT of $100,000,000. Add back D&A of $20,000,000 and you have EBITDA of $120,000,000. That add-back is correct as far as it goes: depreciation was not cash. What it does not do is pay the tax, the capex, or the working capital the operations actually needed.

Walk the same sheet the other way. Tax at 25 percent on EBIT is $25,000,000, so NOPAT is $75,000,000. Add back the same $20,000,000 of D&A, subtract $30,000,000 of capex, subtract a $10,000,000 increase in net working capital. Unlevered free cash flow is $55,000,000.

Hold every other line and let working capital fall by $5,000,000 instead. FCF becomes $70,000,000. EBITDA is still $120,000,000. Capex of $50,000,000 on the original sheet drops FCF to $35,000,000. EBITDA still has not moved.

How free cash flow works is the long form, with the free cash flow calculator under the answer. Enterprise value is the stock identity this flow is supposed to price.

Do not line them up as a gap

A DCF of the firm discounts free cash flow. An EV/EBITDA multiple prices a different claim: operations before tax, capex and working capital. Lining the two up without walking the bridge is how a model double-counts, or skips, the cash the operations actually need.

Unlevered FCF is also not levered free cash flow to equity. It does not subtract interest, debt repayments, or new borrowing. Mixing those two is the same error as comparing a firm DCF with equity value. This is educational material, not financial advice.

Worked examples

The five-line teaching sheet

EBIT is $100,000,000, the tax rate is 25 percent, D&A is $20,000,000, capex is $30,000,000, and net working capital rises by $10,000,000. What is unlevered free cash flow?

  1. Tax on EBIT: 0.25×100000000=250000000.25 \times 100000000 = 25000000, so $25,000,000.
  2. NOPAT: 100000000−25000000=75000000100000000 - 25000000 = 75000000, so $75,000,000. The same figure as 100000000×(1−0.25)100000000 \times (1 - 0.25).
  3. Add back D&A, subtract capex, subtract the working-capital increase: 75000000+20000000−30000000−10000000=5500000075000000 + 20000000 - 30000000 - 10000000 = 55000000, so $55,000,000.
  4. EBITDA is EBIT plus D&A: 100000000+20000000=120000000100000000 + 20000000 = 120000000, so $120,000,000. That is not cash.

NOPAT is $75,000,000. Unlevered free cash flow is $55,000,000.

Working capital as a source of cash

Keep EBIT at $100,000,000, tax at 25 percent, D&A at $20,000,000 and capex at $30,000,000. Net working capital falls, so the delta is -5000000. What is FCF?

  1. NOPAT is still $75,000,000. Tax is still $25,000,000.
  2. The working-capital line is now added, not subtracted: 75000000+20000000−30000000−(−5000000)=7000000075000000 + 20000000 - 30000000 - (-5000000) = 70000000, so $70,000,000.

Free cash flow is $70,000,000. NOPAT did not change. The working-capital release did.

Heavier capex on the same NOPAT

Back to a $10,000,000 working-capital increase. Capex is now $50,000,000. EBIT, tax and D&A are the first sheet. What is FCF?

  1. NOPAT is still $75,000,000.
  2. FCF: 75000000+20000000−50000000−10000000=3500000075000000 + 20000000 - 50000000 - 10000000 = 35000000, so $35,000,000.

Free cash flow is $35,000,000. Capex of $50,000,000, not a change in profit, is what moved the answer.

Common questions

Why do people still quote EBITDA?

Because it is quick, and because it sits in the denominator of a common enterprise-value multiple. It is a starting point. It becomes a problem when it is treated as cash the firm can pay out, which this sheet's $120,000,000 against $55,000,000 of FCF is there to stop.

Is a higher EBITDA always more cash?

No. Raise capex or working capital and FCF falls while EBITDA holds still. A year of deferred capex can make FCF look strong and leave EBITDA unchanged the other way. Read both lines.

Keep reading

This page is educational material, not financial advice. The figures come from the formula shown and assume the inputs you enter hold for the whole term. Your own rate, fees, taxes and timing will differ, so treat the output as arithmetic to check a decision against, not as a recommendation.