Paper LBO clarification
Hey monkeys, I’m preparing to make the switch from banking to PE. I’ve used all of our firms internal resources, done every prompt I can find online, etc. I think I’m relatively well prepared. But the one thing I haven’t seen is the mechanics of working down to cash flow from EBITDA instead of NI on paper LBOs. In that case, would you just use EBITDA as the direct proxy for FCF and immediately subtract capex and changes in NWC? I’m assuming you’d also have to subtract interest expense and taxes as well, so I’m not sure what the difference actually is in working down from EBITA except that D&A is already baked in. Hopefully my question makes sense, any thoughts are appreciated.
Edit: Conceptually I understand why a PE firm is likely to see cash flow as a function of EBITDA vs NI, with EBITDA removing consideration of non-cash expenses and effects of the capital structure which would likely be refi’d when acquired. Just want to be sure that my assumptions of the mechanics is correct in the original post, or see why they’re wrong
Based on the most helpful WSO content, your understanding is on the right track, but let’s clarify the mechanics for working down to cash flow from EBITDA in a paper LBO:
Start with EBITDA: This is your starting point as it represents the operating performance of the business before considering capital structure and non-cash expenses.
Subtract Capex: Capital expenditures are necessary for maintaining or growing the business, so they reduce cash flow.
Adjust for Changes in Net Working Capital (NWC): If NWC increases, it’s a use of cash (subtract it). If NWC decreases, it’s a source of cash (add it).
Subtract Cash Interest Expense: Since you’re working with levered cash flow, you need to account for the interest expense on the debt.
Subtract Cash Taxes: Taxes are a real cash outflow and must be deducted.
This approach essentially mirrors the calculation of levered free cash flow (FCF), which is EBITDA less capex, changes in NWC, interest expense, and taxes. The key difference from working down from net income (NI) is that starting with EBITDA avoids the need to add back non-cash expenses like depreciation and amortization (D&A), as they are already excluded.
Your edit is also correct—PE firms often focus on EBITDA because it provides a clearer view of the operating performance, independent of the capital structure and non-cash accounting items, which are likely to change post-acquisition.
For further insights, you can explore related discussions on WSO, such as the mechanics of EBITDA to FCF calculations:
url: https://www.wallstreetoasis.com/forum/investment-banking/ebitda-vs-oper…
Sources: EBITDA vs. Operating Cash Flow vs. Free Cash Flow, EBITDA vs. Operating Cash Flow vs. Free Cash Flow, How do you get from EBITDA to free cash flow?, Paper LBO Timing
Thanks bot this was helpful
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