This is beneficial because investors comparing companies and performance over time are interested in the operating performance of the enterprise irrespective of its capital structure.Ģ. EBITDA takes an enterprise perspective (whereas net income, like CFO, is an equity measure of profit because payments to lenders have been partially accounted for via interest expense). For our purposes, let’s assume we’re just talking about EBIT + D&A. Many companies and industries have their own convention for calculating of EBITDA (they may exclude non-recurring items, stock-based compensation, non-cash items other than D&A, and rent expense). Free Cash Flow (FCF)ĮBITDA, for better or for worse, is a mixture of CFO, FCF, and accrual accounting. In other words, it identifies how much cash the company can distribute to providers of capital regardless of the company’s capital structure. It also takes the perspective of all capital providers instead of just equity owners. The advantage over CFO is that it accounts for required investments in the business, such as capex (which CFO ignores). It represents cash during a given period available for distribution to all providers of capital. This is the cash flow figure used to calculate cash flows in a DCF. It ignores the tax benefit of interest expense and subtracts capital expenditures from CFO. The advantage of FCFF over CFO is that it identifies how much cash the company can distribute to providers of capital, regardless of the company’s capital structure.įCFF adjusts CFO to exclude any cash outflows from interest expense. Let’s discuss FCFF, since that’s the one investment bankers use most often (unless it is a FIG banker, in which case he/she will be more familiar with FCFE). FCF to equity ( FCFE): Net income + D&A +/- WC changes – Capital expenditures +/- inflows/outflows from debt.FCF to the firm ( FCFF): EBIT*(1-t)+D&A +/- WC changes – Capital expenditures.Operating Cash Flowįree cash flow (FCF) actually has two popular definitions: Learn More → EBITDA Quick Primer Free Cash Flow vs. The flip side of that coin is CFO’s primary downside: You don’t get an accurate picture of ongoing profitability. It’s harder to manipulate CFO than accounting profits (although not impossible, since companies still have some leeway in whether they classify certain items as investing, financing or operating activities, thereby opening the door for manipulating CFO). The benefit of CFO is that it is objective. Two identical companies can have very different income statements if the two companies make different (often arbitrary) deprecation assumptions, revenue recognition and other assumptions. Since accrual accounting depends on management’s judgment and estimates, the income statement is very sensitive to earnings manipulation and shenanigans. However, we should not rely solely on accrual-based accounting, either, and must always have a handle on cash flows. While its CFO may be very low as it ramps up working capital investments, its operating profits show a much more accurate picture of profitability (since the accrual method used for calculating net income matches the timing of revenues with costs). Imagine if you only looked at cash from operations for Boeing after it secured a major contract with an airliner. We wrote an article about this here, but to summarize: Accounting profits are an important complement to cash flows. CFO is an extremely important metric, so much so that you might ask, “What’s the point of even looking at accounting profits (like Net Income or EBIT, or to some extent, EBITDA) in the first place?”
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