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IB Prep

Accounting · 4 min read

EBITDA vs free cash flow: what's the difference?

EBITDA is the most quoted profit measure in banking, and one of the most misunderstood. Interviewers often ask why it isn't the same as cash flow.

What EBITDA leaves out

  • Capex: the money spent on equipment and buildings to keep the business running and growing.
  • Changes in working capital: cash tied up in stock and money customers haven't paid yet.
  • Tax and interest: real cash payments to the government and lenders.

Unlevered free cash flow, step by step

  1. Start with EBIT and take off tax: EBIT × (1 − tax rate). This is NOPAT.
  2. Add back depreciation and amortisation, because no cash left the business.
  3. Subtract capex.
  4. Subtract the increase in net working capital (or add a decrease).

Example: EBIT £100m, D&A £20m, capex £30m and a £10m increase in working capital, at a 25% tax rate. NOPAT is £75m; add £20m, subtract £30m and £10m: unlevered free cash flow is £55m, against EBITDA of £120m.

Why it matters

Two companies with the same EBITDA can be worth very different amounts if one needs far more capex or working capital. That's why a DCF uses free cash flow, and why bankers look at cash conversion: (EBITDA − capex) ÷ EBITDA.

Check you've got it

1/3

Work it out

EBIT is £100m, D&A £20m, capex £30m, and net working capital increases by £10m. What is unlevered free cash flow, in £m?

Assumes: Tax rate of 25% (the UK main rate of corporation tax).