EBITDA walkdown to cash flow for debt service
Hi, I'm an MBB consultant taking a modeling test soon and trying to understand the following: how do you get from EBITDA to FCF available for debt service, without deducting interest payment?
What I have generally seen in LBO models is that the cash flow statement starts with Net Income:
EBITDA - D&A = EBIT
EBIT - Interest expense = EBT
EBT * (1 - tax rate) = Net income
Net income + D&A - CAPEX - Increase in NWC = Cash flow available for debt service
In the case that was described to me by the headhunter, the steps in the model are as follows:
EBITDA > EBIT > Net income > Cash Flow > EBITDA > FCF available for debt service > mandatory repayments / interest > FCF post interest
I don't understand how the interest expense could be ignored in the walkdown to net income, we would be ignoring the tax shield which is one of the reasons why these transactions use a large amount of debt
Also I don't understand why the steps go back to EBITDA after the cash flows have been calculated
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Your comment was very helpful, thank you
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When you build a debt paydown waterfall you do deduct the interest.
The second thing you're describing (EBITDA to FCF) is calculating the "unlevered" (i.e., no assumption of debt in the cap structure) free cash flow of a business independent of capital structure. Get your hands on a real LBO model and you can see the waterfall from there - some models start with the unlevered free cash flow and then there are many subsequent lines that build out the interest / voluntary / mandatory debt amort payments.
The interest needs to be calc'd in excel because with the amort sweep it's going to be iterative (i.e., the more interest you have, the less levered FCF available to sweep debt which impacts the ending debt balance which impacts the interest calc...)
Debt Service usually means the sum of interest expense and scheduled amortization.
What you're really trying to drive at is Free Cash Flow to Firm (i.e., before debt service) which is EBITDA less Cash Taxes less Change in NWC less Capex.
If you want to have your tax figure to not have the benefit of any interest tax shield, you can do EBIT * (1 - effective tax rate) + D&A - Change in NWC - Capex where effective tax rate is usually 25% (21% federal + 4% state)
Thank you, I appreciate the response! Trying to recap, can you please let me know if I am understanding correctly?
Starting from EBITDA, deducting D&A gets me to EBIT. From EBIT, I substract taxes which gets me to NOPAT (the HH mentioned net income but I don't think it's correct to call it net income?)
Then from NOPAT I can build cash flow from operations by adding back D&A and deducting increase in NWC, and then deduct cash flow from investing (CAPEX). This gets me to unlevered FCF (or FCF available for debt paydown)
Separately, I built out my debt schedule and compute net interest expense, mandatory repayment and cash sweep, and use the sum of these to calculate cash flow from financing activities. Unlevered FCF - cash flow from financing = Levered FCF or FCF after debt has been serviced
Your wording is awkward and going to confuse you.
Here is is:
EBITDA
(D&A)
EBIT
(Taxes)
NOPAT (Net Operating Profit After Tax- Not Net income since we didn’t subtract any interest because we want unlevered FCF)
+ D&A / other Non Cash Charges like SBC and Amortization of fees
- / + Change in NWC (could be positive or negative- remember how sources and uses work)
(CapEx)
Cash Flow for Debt Repayment
regarding the second portion of what you typed, just take a look at an actual LBO model and it will make so much more sense to you.
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