Why EBITDA Doesn’t Spell Cash Flow and What Does?

EBITDA is not cash flow and it can be misleading and costly to the lender in certain credit decisions. 

The challenge here is to explain what we mean when we say cash flow. In recent decades bankers have seen several top contenders for the cash flow definitional sweepstakes—traditional cash flow, operating cash flow, and EBITDA. The ascendant definition has been EBITDA, largely because of its popularity with the investment community, and its use there has given it a certain cache among corporate bankers and commercial lenders.

EBITDA is a popular measure of cash flow, but it is not accurate, and bankers and investors who rely on it as a reliable indicator of repayment ability will be deeply disappointed. The lender needs to understand those fatal flaws so that they do not jeopardize the repayment of what otherwise appears to be a strong credit.

The session includes several examples and a case study to illustrate:

• Why EBITDA is flawed and how to apply better cash flow tools that actually measure repayment ability from cash flow.
• Discover the alternatives to EBITDA including Operating Cash Flow, Net Cash after Operation, Net Cash Income, Cash after Debt Amortization, and Free Cash Flow.

Most bankers acknowledge that construction lending is riskier than other types of commercial lending:

• Repayment ability depends on successful completion of the construction before the project can generate cash flow from the sale of the finished property, from rental or lease of the real estate, or from permanent take-out refinancing
• During the construction period, the collateral is literally work-in-progress, and often the guarantors do not have sufficient outside net worth or income to pay off the loan

In the world of financial analysis, EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization) has long been a favored metric for evaluating a company's operational performance. Its popularity stems from its simplicity and its ability to offer a snapshot of a company's profitability, independent of its capital structure and accounting practices. However, a critical aspect often overlooked is that EBITDA does not directly translate into cash flow, leading to the need for a deeper exploration of the relationship between EBITDA and true cash generation. By exploring the shortcomings of EBITDA and highlighting more reliable indicators, stakeholders can make more informed financial assessments, ultimately contributing to sound investment decisions and a better understanding of a company's financial health.