I was bored and reading through my old vault and interview guides from a couple of years ago, and noticed that one of the questions that we ask in interviews (albeit an unfair one - i didn't know the answer till I started banking) is the differences between EBIT and EBITDA, and why EBITDA is not cash flow.
This article goes into a good summary of this.
http://www.bonato.com.ar/Archivos/Moodys%20EBITDA…
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EBITDA=EBIT+Depreciation(non-cash item)+amortization(non-cash item) is this rite?
It's funny how widely believed it is that EBITDA is a good proxy for cash flow when in reality it is a very poor one.
i thought everyone knows this. Clearly depreciation and amortization are non-cash expenses, hence the bad proxy for cash flow and the difference between EBIT and EBITDA
See, EBIT and EBITDA are not good proxys for cashflow. I suggest every prospesctive monkey read the article and understand it.
The most common answer we get when we as "Why is EBITDA not a good CF metric?", they say "because it has depreciation and amortization which are non-cash items.."
No. EBITDA is earnings before interest taxes and DEPRECIATION AND AMORTIZATION. But even though it does not include the non cash stuff, it is still not a good proxy. I interviewed 16 kids at one of our targets and only 2 or 3 fully understood the concept.
Exactly. EBITDA ignores changes in working capital (and overstates cf in periods of WC growth), nor does it consider the amount of required reinvestment, particularly if the company has short lived assets, and it also ignores the quality of cash flow resulting from different accounting policies (keep in mind that not all revenues reported are cash revenues). Moreover, if you are using EBITDA as a measure of liquidity, it can be misleading because it does not consider potential near-term claims on cash i.e. direct obligations as well as contingent obligations, funding needs to support working capital, or the vulnerability to reduced access to capital markets (particularly relevant in this market).
There are other reasons why EBITDA isn't a good proxy for cash flow, but as monkeykingdom previously said every prospective monkey should read the article and understand this concept.
because it does not take into account working capital variations... and tax implications, which can both be HUGE!
A good proxy is to test an EBITDA conversion rate ie FCF/EBITDA to see how off it really is. Most companies will spit out less than 60% of EBITDA in cash... a 40% difference is HUGE!!! its the difference between default and metting interest payments with excess cash on hand..
The link to the article is broken. Does anyone have a copy of this PDF saved that they could upload somewhere?
Bump. Like monkeys uncle mentioned, the link is broken.
Hey the link is broken can some1 plz explain...
https://community.bus.emory.edu/club/GIM/Shared%20Documents/Putting%20EBITDA%20Into%20Perspective.pdf
not sure if its the same article here, but this sums it up nicely.
this is embarrassing
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