I was asked in an Interview if EBITDA is a proxy for Cashflow. I have heard it is, but I do not quite understand it. In which context is it used as a proxy for CF? And which type of CF? And why then not use the CF itself? Would really appreciate some explanation
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they meant FCF, and it's a proxy for a dirty valuation
but even if they meant CF, the real question is to look what's excluded in EBITDA compared to the CF and ask urself why they may want to disregard this in this business as thr "proxy" is industry-dependant
So basically they mean just EBITDA is easier to calculate than FCF and therefore they just take that? But I mean, in other valuations they use FCF, why do they in this case then say its not easy enough to calculate? And i guess the statement is generally made in connection to multiple valuation right? Still don't really get it because, for some industries it might be an okay proxy but for many i would think it is kind of useless as a proxy for FCF, as they are generally very different
You have to think about what EBITDA is and isn't telling you compared to what various types of cash flows (such as levered and unlevered) are and aren't telling you.
You also have to consider the question "who does this cash 'belong' to?" Is it debt-holders and shareholders? Just one of the two?
To answer the first question, EBITDA doesn't really tell you about CapEx, which is typically a large cash outflow (obviously industry dependent) and is taken into account for the two cash flows I mentioned above. EBITDA also doesn't have changes in working capital being accounted for, which the two cash flows above do. Again, obviously very industry dependent, but they do need to be considered.
In terms of who EBITDA "belongs" to, because interest payments and mandatory amortization are not taken out of EBITDA, this is a cash flow that "belongs" to all stakeholders, and is therefore "closer" to unlevered free cash flow. This is why EBITDA is used is so many valuation metrics such as EV/EBITDA, given that EV is a valuation of the entire company when taking into account all stakeholders, not just the shareholders. If we were considering levered free cash flow, this is cash flow where the debt-holders have been given their interest and mandatory amortization, then the cash left over "belongs" to the shareholders only.
So when would EBITDA be a better proxy for cash flow? Obviously it's very industry dependent but very broadly, when there are low capital expenditures and small changes in working capital, EBITDA will be a better proxy for unlevered free cash flow. And when the company also doesn't have large interest expenses or mandatory amortization, it will be a better proxy for levered free cash flow.
But why don't just take the Cash Flow, why would you need a proxy for it? And why not for example EBIT, it is also capital structure neutral and also includes the D&A which can be an indication for Capex
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