Cash flow and EBITDA are 2 powerful financial metrics that provide valuable insights into your business’s financial health, yet they approach this task from different angles.
How similar are they, and is one more important than the other for your business?
Let’s find out!
Read on to learn more about cash flow vs. EBITDA and their similarities and differences.
What is Cash Flow?
Cash flow refers to the movement of money into and out of a business during a specific period.
It is a critical financial metric that indicates your business’s liquidity and overall financial health.
Cash flow can be positive or negative. The positive cash flow happens when the inflows (money received) exceed the outflows (money spent).
Therefore, your business has enough cash to:
- Cover its expenses,
- Invest in growth,
- Pay debts, and
- Provide returns to shareholders.
On the other hand, the negative cash flow occurs when the outflows exceed the inflows, signaling that your business is struggling financially.
Consequently, prolonged negative cash flow can lead to difficulties meeting operational expenses and jeopardize your business's sustainability.
Types of Cash Flow
Operating Cash Flow — Generated from the core business operations, including revenues from sales and payments from customers minus costs and expenses.
Investing Cash Flow — Used for or generated from investments in assets, such as purchasing equipment or property, and proceeds from selling assets.
Financing Cash Flow — Received from or paid to investors and creditors, including any dividends, loan repayments, or issuing new shares.
Free Cash Flow (FCF) — The cash you’ve generated after accounting for capital expenditures you needed to maintain or expand the asset base.
How to Calculate Cash Flow?
Formulas to calculate cash flow differ depending on the type of cashflow, but let’s go through the core ones:
- Net Cash equals the total cash inflows and outflows during a certain period.
- Operating Cash Flow is the sum of Non-cash Expenses or Depreciation and Changes in Working Capital.
- Investing Cash Flow represents Cash Inflows from Investing Activities minus Cash Outflows from Investing Activities.
- Financing Cash Flow equals Cash Inflows from Financing Activities minus Cash Outflows from Financing Activities.
- Free Cash Flow represents Operating cash flow minus capital expenditures you need to maintain or expand your asset base.
Jump to our blog, All Cash Flow Formulas You Need to Know [Explained], for a detailed explanation of the importance of these crucial metrics.
What Does Cash Flow Reveal About Your Business?
Understanding cash flow is essential for effective financial management.
It helps with planning, budgeting, and ensuring there is enough cash available to meet liabilities when they are due.
💰 Financial Health Indicator
Cash flow analysis helps you assess your ability to meet short-term obligations, invest in opportunities, and sustain operations.
💰 Comparison and Benchmarking
You can compare cash flow across periods or against industry peers, providing a reliable performance measure.
Unlike profits, which can be subject to accounting practices, cash flow is more difficult to manipulate, making it a trustworthy metric for evaluating business viability.
💰 Decision-Making Tool
Cash flow statements can help you identify trends, strengths, and areas for improvement.
As a result, you can make better budgeting decisions and operational adjustments, as well as develop investment strategies.
For instance, if cash flow from operations declines, you may need to reevaluate your pricing strategy or cost structure.
💰 Growth and Sustainability
Positive cash flow allows you to reinvest in operations, pay down debt, and return value to shareholders.
Moreover, it is a buffer against economic downturns, enabling you to navigate financial challenges.
Overall, regular cash flow analysis empowers you to make strategic decisions that align with your financial goals and market conditions.
What is EBITDA?
EBITDA stands for Earnings Before Interest, Taxes, Depreciation, and Amortization.
It is a financial metric used to evaluate your company's operating performance and profitability.
EBITDA focuses on earnings generated from core business activities but excludes non-operational factors and non-cash expenses.
EBITDA’s Components
In order to calculate EBITDA, you need to know its components and what they represent.
- Earnings — Refers to the net income generated from operations.
- Interest — Cost incurred on borrowed funds, which is excluded because it can vary between companies based on their financing structure.
- Taxes — Excluded to provide a clearer picture of operating performance regardless of tax strategies.
- Depreciation and Amortization — Non-cash expenses related to the gradual reduction in value of tangible and intangible assets.
How to Calculate EBITDA?
You can calculate EBITDA in 2 different ways:
- From your revenue, subtract operating expenses while adding depreciation and amortization.
EBITDA = Revenue − Operating Expenses + Depreciation + Amortization,
and alternatively,
- From operating income (EBIT), add back depreciation and amortization:
EBITDA = EBIT + Depreciation + Amortization.
Another important factor regarding EBITDA is the margin, which you calculate by dividing EBITDA by total revenue.
It indicates how efficiently your company operates compared to its revenue.
📌 Did you know you can convert the FCF into EBITDA and vice versa?
What Does EBITDA Reveal About Your Business?
By focusing on earnings derived from core business activities, EBITDA allows stakeholders to assess your company's financial health without the influence of non-operational factors.
Furthermore, EBITDA provides insights into:
💰 Operational Performance
EBITDA offers a clearer view of operational efficiency by excluding interest, taxes, and non-cash expenses like depreciation and amortization.
This makes it particularly useful for comparing companies within the same industry, regardless of their capital structures or tax situations.
💰 Profitability Assessment
It measures baseline profitability, providing a snapshot of earnings that you can compare across different periods or against competitors.
The EBITDA margin plays an important role here, and a higher one suggests better operational efficiency and profitability.
💰 Strategic Decision-Making
EBITDA is a critical tool for strategic planning, both for business owners and investors, since it can pinpoint inefficiencies and optimize operations to enhance profitability.
It identifies areas for improvement and empowers decisions regarding investments, cost management, and operational adjustments.
💰 Valuation and Investment Analysis
It is instrumental in mergers and acquisitions, providing a straightforward measure of your company's earning capacity.
In addition, investors often prefer EBITDA over net income because it eliminates variables that can obscure the company's actual operational performance.
Cash Flow vs. EBITDA: Where Do They Differ?
Cash flow and EBITDA are similar terms, and both assess your company's financial performance, but they serve different purposes and provide distinct insights.
Let’s check the key differences between the two.
1. Definition
Cash Flow refers to the net amount of cash moving into and out of a business over a specific period.
It includes:
- All sources of cash inflows, such as revenue from operations, asset sales, and financing activities, and
- All cash outflows, such as operating expenses, capital expenditures, and debt repayments.
Cash flow measures your company's liquidity and ability to meet short-term obligations.
Conversely, EBITDA measures operating performance that reflects earnings from core business operations before the effects of:
- Interests,
- Tax strategies, and
- Non-cash accounting items, such as depreciation and amortization.
2. Components
Cash flow encompasses all cash inflows and outflows, including operating cash flow, investing cash flow, and financing cash flow, to indicate your business's overall liquidity position.
EBITDA focuses solely on earnings derived from operations, adjusting for interest, taxes, depreciation, and amortization.
Therefore, it doesn’t represent actual cash flow because it excludes changes in working capital, capital expenditures, and other cash-flow considerations.
3. Purpose
You use cash flow to assess your company's liquidity and financial health.
As such, it answers questions about whether the company can meet its financial obligations and fund its day-to-day operations.
On the other hand, EBIDTA evaluates operational performance and profitability.
Consequently, it is helpful for comparing profitability across companies in the same industry since it removes the effects of financing and accounting decisions.
4. Perspective
Cash Flow is a more comprehensive measure of financial health since it reflects the actual cash that your company has on hand after all cash inflows and outflows have been accounted for.
EBITDA focuses more on profitability, making it appealing to investors and analysts who want to evaluate ongoing operational performance without the noise of capital structure and tax effects.
Wrapping It Up
While both cash flow and EBITDA are valuable metrics for assessing your company's financial performance, they provide different perspectives.
Cash flow offers insight into liquidity and the ability to cover short-term obligations, while EBITDA focuses on operational profitability.
Despite cash flow being a broader term, analyzing both metrics together can give a more comprehensive view of your company's financial health and performance.
How Can Puls Project Help?
Puls Project is an all-in-one solution that provides advanced financial tools to SMBs to:
- Manage and track cash flow effectively.
- Get necessary funding.
- Centralize all your financial activities and view and manage all companies and accounts from a single dashboard.
Being such a robust and versatile tool makes Puls Project a great assistant in improving your cash flow and making your business more appealing to potential investors.
💰 Connect multiple accounts from over 4000 banks and view and manage them in one place.
💰 Centralize financial management and track balances and spending across different accounts and companies in a single view.
💰 Rely on accurate, real-time data for business decisions since we automatically sync all your transactions multiple times daily.
💰 Automate expense tracking by inputting your regular expenses once, and you will see them the following month as well.
💰 Monitor your cash flow actively, and we’ll let you know when we detect a gap so you can make necessary adjustments and asset relocation.
💰 Set future-dated drafts to instantly see their impact on your cash flow for better decisions.
💰 Get a business loan up to €100,000 for 12 months within 48 hours — No complex forms, no banks or other 3rd parties because we issue loans from our credit fund registered with BaFin.
💰 Tailor the loan to your needs and only pay back what you’ve spent.
💰 Build your credibility by accurately matching your draft payments with the actual ones, increasing your available credit.
And so much more.
Want to see Puls Project in action?
Sign up for Puls Project today and turn challenges into strategic triumphs.
FAQ
1. Is EBITDA a Good Indicator of Profitability?
EBITDA is a good indicator of how well your company is performing operationally.
However, since it doesn’t account for changes in working capital, capital expenditures, and actual cash flow, your company may show strong EBITDA while struggling with cash flow issues.
Furthermore, EBITDA isn’t considered a standard GAAP (Generally Accepted Accounting Principles) metric.
Thus, companies may calculate it differently, making comparisons less reliable.
Although EBITDA can be a valuable indicator of profitability, you need to have a more holistic approach and consider it alongside other metrics, including net income, cash flow, and various profitability ratios.
2. What is The Cash Flow to EBITDA Ratio?
The Cash Flow to EBITDA Ratio is a financial metric which evaluates your company's ability to convert its earnings, EBITDA, into actual cash flow.
Cash Flow to EBITDA Ratio = Operating Cash Flow / EBITDA
This ratio provides insights into a company's efficiency of operations and capacity to generate cash based on its earnings.
A higher ratio suggests that a company effectively turns its EBITDA into tangible cash flow, while a lower ratio may indicate potential issues with cash generation or working capital management.
3. Is Cash Flow The Same as Profit?
No, cash flow and profit aren’t the same. Cash flow looks at the actual movement of cash, while profit includes non-cash items.
Cash flow can be positive or negative, while profit is always a surplus after expenses. Moreover, cash flow is on the cash flow statement, while profit is on the income statement.
Keep Learning:
Cash Burn Rate for Better Cash Control: Explanation
The Key to Financial Stability: Tips for Liquidity Planning
Effective Financial Planning: The Backbone of German SME Success
