Abstract
Lenders, investors and business owners use cash metrics to evaluate a businesses financial health and its ability to repay loans or generate cash flows to execute on strategic plans. Two metrics are commonly used, each having unique mechanics of calculation and often, differing results.
Professional literature clearly states that cash flows from operations, a calculation embodied in a Statement of Cash Flows included in a businesses financial statements, is the appropriate calculation of operating cash flow generation or use. Cash flows from operations uses information from all activities related to the income statement.
Since the 1980’s, investors and lenders have continued to use a short cut calculation to measure cash flows focused only on the income statement, EBITDA, earnings before interest, taxes, depreciation and amortization. The use of EBITDA as a measure of operating cash flows ignores balance sheet items that are affected by activities reflected in the income statement, and therefore, may not reflect cash generation or use performance as accurately as cash flows from operations.
The article attempts to give the reader an understanding of the definition of terms to enable discussions with lenders and investors, the calculations and their strengths and pitfalls when used to measure cash generated or used. A simple example points out a significant variance between the two calculations.
Keywords: EBITDA, operating cash flow.
8
2