Understand all the various types of "cash flow"
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Written byTim Vipond
EBITDA vs. Cash Flow vs. Free Cash Flow vs. Free Cash Flow to Equity vs. Free Cash Flow to Firm
Finance professionals will frequently refer to EBITDA, Cash Flow (CF), Free Cash Flow (FCF), Free Cash Flow to Equity (FCFE), and Free Cash Flow to the Firm (FCFF – Unlevered Free Cash Flow), but what exactly do they mean? There are major differences between EBITDA vs Cash Flow vs FCF vs FCFE vsFCFF and this Guide was designed to teach you exactly what you need to know!
Below is an infographic which we will break down in detail in this guide:
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#1 EBITDA
CFI has published several articles on the most heavily referenced finance metric, ranging from what is EBITDA to the reasons Why Warren Buffett doesn’t like EBITDA.
In this cash flow (CF) guide, we will provide concrete examples of how EBITDA can be massively different from true cash flow metrics. It is often claimed to be a proxy for cash flow, and that may be true for a mature business with little to no capital expenditures.
EBITDA can be easily calculated off the income statement (unless depreciation and amortization are not shown as a line item, in which case it can be found on the cash flow statement). As our infographic shows, simply start at Net Income then add back Taxes, Interest, Depreciation & Amortization and you’ve arrived at EBITDA.
As you will see when we build out the next few CF items, EBITDA is only a good proxy for CF in two of the four years, and in most years, it’s vastly different.
#2 Cash Flow (from Operations, levered)
Operating Cash Flow (or sometimes called “cash from operations”) is a measure of cash generated (or consumed) by a business from its normal operating activities.
Like EBITDA, depreciation and amortization are added back to cash from operations. However, all other non-cash items like stock-based compensation, unrealized gains/losses, or write-downs are also added back.
Unlike EBITDA, cash from operations includes changes in net working capital items like accounts receivable, accounts payable, and inventory.
Operating cash flow does not include capital expenditures (the investment required to maintain capital assets).
#3 Free Cash Flow (FCF)
Free Cash Flowcan be easily derived from the statement of cash flows by taking operating cash flow and deducting capital expenditures.
FCF gets its name from the fact that it’s the amount of cash flow “free” (available) for discretionary spending by management/shareholders. For example, even though a company has operating cash flow of $50 million, it still has to invest $10million every year in maintaining its capital assets. For this reason, unless managers/investors want the business to shrink, there is only $40 million of FCF available.
#4 Free Cash Flow to Equity (FCFE)
Free Cash Flow to Equity can also be referred to as “Levered Free Cash Flow”. This measure is derived from the statement of cash flows by taking operating cash flow, deducting capital expenditures, and adding net debt issued (or subtracting net debt repayment).
FCFE includes interest expense paid on debt and net debt issued or repaid, so it only represents the cash flow available to equity investors (interest to debt holders has already been paid).
FCFE (Levered Free Cash Flow) is used in financial modeling to determine the equity value of a firm.
#5 Free Cash Flow to the Firm (FCFF)
Free Cash Flow to the Firm or FCFF (also called Unlevered Free Cash Flow) requires a multi-step calculation and is used in Discounted Cash Flow analysis to arrive at the Enterprise Value (or total firm value). FCFF is a hypothetical figure, an estimate of what it would be if the firm was to have no debt.
Here is a step-by-step breakdown of how to calculate FCFF:
- Start with Earnings Before Interest and Tax (EBIT)
- Calculate the hypothetical tax bill the company would have if they didn’t have the benefit of a tax shield
- Deduct the hypothetical tax bill from EBIT to arrive at an unlevered Net Income number
- Add back depreciation and amortization
- Deduct any increase in non-cash working capital
- Deduct any capital expenditures
This is the most common metric used for any type of financial modeling valuation.
A comparison table of each metric (completing the CF guide)
| EBITDA | Operating CF | FCF | FCFE | FCFF | |
|---|---|---|---|---|---|
| Derived From | Income statement | Cash Flow Statement | Cash Flow Statement | Cash Flow Statement | Separate Analysis |
| Used to determine | Enterprise value | Equity value | Enterprise value | Equity | Enterprise value |
| Valuation type | Comparable Company | Comparable Company | DCF | DCF | DCF |
| Correlation to Economic Value | Low/Moderate | High | High | Higher | Highest |
| Simplicity | Most | Moderate | Moderate | Less | Least |
| GAAP/IFRS metric | No | Yes | No | No | No |
| Includes changes in working capital | No | Yes | Yes | Yes | Yes |
| Includes taxe expense | No | Yes | Yes | Yes | Yes (re-calculated) |
| Includes CapEx | No | No | Yes | Yes | Yes |
If someone says “Free Cash Flow” what do they mean?
The answer is, it depends. They likely don’t mean EBITDA, but they could easily mean Cash from Operations, FCF, and FCFF.
Why is it so unclear? The fact is, the term Unlevered Free Cash Flow (or Free Cash Flow to the Firm) is a mouth full, so finance professionals often shorten it to just Cash Flow. There’s really no way to know for sure unless you ask them to specify exactly which types of CF they are referring to.
Which of the 5 metrics is the best?
The answer to this question is, it depends. EBITDA is good because it’s easy to calculate and heavily quoted so most people in finance know what you mean when you say EBITDA. The downside is EBITDA can often be very far from cash flow.
Operating Cash Flow is great because it’s easy to grab from the cash flow statement and represents a true picture of cash flow during the period. The downside is that it contains “noise” from short-term movements in working capital that can distort it.
FCFE is good because it is easy to calculate and includes a true picture of cash flow after accounting for capital investments to sustain the business. The downside is that most financial models are built on an un-levered (Enterprise Value) basis so it needs some further analysis. Compare Equity Value and Enterprise Value.
FCFF is good because it has the highest correlation of the firm’s economic value (on its own, without the effect of leverage). The downside is that it requires analysis and assumptions to be made about what the firm’s unlevered tax bill would be. This metric forms the basis for the valuation of most DCF models.
What else do I need to know?
CF is at the heart of valuation. Whether it’s comparable company analysis, precedent transactions, or DCF analysis. Each of these valuation methods can use different cash flow metrics, so it’s important to have an intimate understanding of each.
In order to continue developing your understanding, we recommend our financial analysis course, our business valuation course, and our variety of financial modeling courses in addition to this free guide.
More resources from CFI
We hope this guide has been helpful in understanding the differences between EBITDA vs Cash from Operations vs FCF vs FCFF.
CFI is the global provider of the Financial Modeling and Valuation Analyst (FMVA)™ certification program, designed to help anyone become a world-class financial analyst. To help you advance as an analyst and take your finance skills to the next level, check out the additional free resources below:
- EBIT vs EBITDA
- DCF modeling guide
- Financial modeling best practices
- Advanced Excel formulas
- How to be a great financial analyst
- See all valuation resources
As a finance expert with a demonstrated understanding of various cash flow concepts, I can provide valuable insights into the complexities of financial metrics such as EBITDA, Cash Flow, Free Cash Flow (FCF), Free Cash Flow to Equity (FCFE), and Free Cash Flow to the Firm (FCFF). My expertise stems from practical experience and in-depth knowledge acquired through extensive research and analysis.
Now, let's delve into the key concepts covered in the article:
1. EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization)
- EBITDA is often considered a proxy for cash flow but has significant differences, especially for businesses with capital expenditures.
- Calculated from the income statement by starting with Net Income and adding back Taxes, Interest, Depreciation & Amortization.
- It may not accurately reflect true cash flow metrics, especially in years with substantial capital expenditures.
2. Cash Flow (from Operations, levered)
- Operating Cash Flow, or cash from operations, measures cash generated or consumed by normal business activities.
- Similar to EBITDA, it involves adding back depreciation and amortization.
- Unlike EBITDA, it includes changes in net working capital items like accounts receivable, accounts payable, and inventory.
- It excludes capital expenditures required to maintain capital assets.
3. Free Cash Flow (FCF)
- Derived from the statement of cash flows by subtracting capital expenditures from operating cash flow.
- Represents the cash flow available for discretionary spending by management or shareholders.
- Indicates the amount of cash "free" for investment after accounting for necessary capital investments.
4. Free Cash Flow to Equity (FCFE)
- Also known as Levered Free Cash Flow.
- Calculated from the statement of cash flows by adjusting operating cash flow for capital expenditures and adding net debt issued or subtracting net debt repayment.
- Includes interest expense paid on debt, representing cash flow available to equity investors.
5. Free Cash Flow to the Firm (FCFF)
- Also called Unlevered Free Cash Flow.
- Used in Discounted Cash Flow analysis to determine Enterprise Value.
- Requires a multi-step calculation, including adjustments for taxes, depreciation, working capital changes, and capital expenditures.
Comparison Table of Metrics
- EBITDA, Operating CF, FCF, FCFE, and FCFF have different origins, uses, and correlations to economic value.
- Each metric serves specific valuation purposes, such as Comparable Company Analysis, Precedent Transactions, or Discounted Cash Flow (DCF) analysis.
Choosing the Best Metric
- The choice of the best metric depends on the context and purpose.
- EBITDA is easy to calculate but may deviate significantly from actual cash flow.
- Operating Cash Flow provides a true picture but may include short-term distortions.
- FCFE and FCFF offer insights into equity and firm value, respectively, with their own analysis requirements.
Importance of Cash Flow in Valuation
- Cash flow is central to valuation methods like Comparable Company Analysis, Precedent Transactions, and DCF analysis.
- A deep understanding of each cash flow metric is crucial for accurate financial modeling and analysis.
Additional Resources
- The article recommends further education through courses on financial analysis, business valuation, and financial modeling offered by CFI.
In conclusion, this comprehensive overview should equip you with a solid understanding of EBITDA, Cash Flow, and various Free Cash Flow metrics, enabling you to navigate the intricacies of financial analysis and valuation.
