How do you get from EBITDA to free cash flow?

I got asked this in an interview and it tripped me up. I can get from Revenue to FCF. My thought process is you take Rev - COGS - Operating expenses = EBIT , then take EBIT * (1-tax rate) then add depreciation, subtract change in working capital and capex.

So to go from EBITDA to FCF do you subtract D&A, tax the EBIT, then add back D&A , subtract capex and change in working capital?

Any help would be appreciated.

Thanks!

EBITDA and FCF Formula

EBITDA, operating cash flow, free cash flow and many other formulas are all fair game when it comes to investment banking interviews. Understanding when each is used and how they relate to one another can set you apart from other candidates.

  • EBITDA: Operating Income + Depreciation + Amoritzation + Stock-Based Compensation
  • Free Cash Flow (FCF): EBIT(1-T) + D&A - Change in NonCash WC - CAPEX

EBITDA to FCF

To get from EBITDA to FCF, the WSO community provides the following answer:

(EBITDA - D&A)(1-tax rate) + non cash adjustments +/- change in working capital - Capex

You add change in working capital if working capital has decreased and subtract if it has increased.

Levered vs. Unlevered Free Cash Flow

One caveat to the above explanation is if you're looking at this from the context of a debt paydown. Most of the time when people talk about FCF, they are approaching it from a valuation perspective and are concerned with unlevered free cash flow. However, if they are interested in levered FCF, then the calculation from EBITDA to FCF would be slightly different.

As WSO user @George_Banker explains, the calculation would be:

EBITDA less cash taxes less cash interest less change in working capital less capex

Want to learn more about important corporate finance formulas to help you break into the investment banking industry?

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Comments (47)

Oct 6, 2017

EBITDA less cash taxes less cash interest less change in working capital less capex

Oct 5, 2017

Wrong, you shouldn't include the interest tax shield

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Oct 6, 2017

Do you understand math or not? Your equation below is exactly what I just said. Do you realize that cash taxes are not just EBITDA*(t)? Think a little...cash taxes are a separate calculation.

Oct 5, 2017

....

Oct 5, 2017

Are you replying to me? Anyway it's EBITDA(1-t)+D&At-Capex-Change in NWC since you normally discount to post-tax WACC, would be double-counting the tax shield otherwise

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Oct 5, 2017

I was going to say something off-topic lmao

But yeah, you are right. You subtract the cash taxes then add back the non-cash D&A to get to operating cash flows and then subtract the NWC and CapEx

Oct 5, 2017

Your equation still yields the same answer as what OP is asking about.

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Best Response
Oct 5, 2017

Didn't really get what OP was saying, but you subtract out D&A to get EBIT, then you strip out the cash taxes. Add the pre-tax D&A back, then subtract delta NWC and CapEx. It's pretty simple, idk what people are saying here.

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Oct 5, 2017

It's (EBITDA - D&A)(1-tax rate) + non cash adjustments +/- change in working capital - Capex

*You add change in working capital if working capital has decreased and subtract if it has increased

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Oct 5, 2017

What class do you learn this in? Current sophomore who keeps seeing EBITDA/DCF/etc. and none of these have been mentioned in my economics or accounting classes so far.

Oct 5, 2017

I learned the concept from the Breaking into Wall Street ib interview prep course.

Oct 5, 2017

Ah ok cool, so it teaches you the concept in the prep course? I haven't purchased because I thought it would only have the technical questions and no walk-through/teaching/explanation.

Oct 6, 2017

Investment Banking: Valuation, Leveraged Buyouts, and Mergers and Acquisitions
by Joshua Rosenbaum and Joshua Pearl is a great book to explain the intricate parts of valuation. Unless you attend a target school that offers an investment banking class, you will not learn what you need to know for ib interviews in school. However, you still need to learn in your university courses or you will have trouble grasping the IB concepts. The book is a great foundational knowledge for IB and WallStreetPrep are great guides for preparing for the interviews.

M

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Oct 6, 2017

Thanks man!

Dec 15, 2017

That's because these are corporate finance questions, not economics or accounting
Take a corporate finance class

Oct 6, 2017

EBIT(1-T)+D&A-Change in WCR-Net Capex=(EBITDA-D&A)(1-T)+D&A-Change in WCR-Net Capex=EBITDA-EBIT*T-Change in WCR-Net Capex

So, technically taxes are cash taxes on EBIT as you usually take into account tax shield through discount rate

Dec 15, 2017

If it is a cash expense then it has impacted your CF by reducing CF for the FY. This goes into the Income Statement.
The expense is again captured on the Income Statement, is this what you are trying to say?

I'm not entirely understanding the wording..

Dec 15, 2017

I think I understand what you're asking...but I'm struggling to understand why there would be an impact on just these two without a BS impact as well...?

If there's an expense running through your IS that also impacts the CF outside of your Net Income line.....shouldn't that cash be hung up somewhere on the balance sheet as well?

In which case, you're really adjusting the CF for the impacts to the BS, not the IS.

Income Statements can be gamed -- things can be reserved, CapEx can be scheduled for end of quarters/years so as to not spin depreciation, etc. You can prepay expenses that will sit on the Balance Sheet and affect Cash but not your IS. When you recognize those expenses, it affects your IS and BS, but not Cash. That said, the expense recognition will flow through your Net Income line to your starting point for Changes in Cash -- which ultimately needs to be adjusted.

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Dec 15, 2017

It depends whether you are talking about non cash charges or charges on the income statement that aren't actually paid until post period end. Non cash charges will simply be added back on the cash flow to get the true net cash movement and will also have to appear on the balance sheet somewhere. For example depreciation is a non cash charge on the IS, this is added back on the CF but deducted from PPE on the BS so the accounting equation still balances.

For charges on the income statement that are not actually paid until post period end, a balance sheet item will be created to ensure the accounting equation balances. For example say a company gets a bill for electricity that isn't paid until after the period ends, the charge is still put through the income statement for the period (accrual accounting) and a liability is created on the balance sheet to balance the accounting equation.

Dec 15, 2017

Here is an example:

Warranty expense (estimate) - Company A estimates that 2% of XYZ widgets will be returned based on historical data; In 2016 Company A sold 1,000 of XYZ widgets at a cost of $10 each.
So, for CY '16 a warranty expense will be recorded for $200 (.02 * $10 * 1,000) with a subsequent warranty liability. No cash effect yet, but an expense is recognized lowering income on the IS.
Let's assume a 40% tax rate. $200 decrease in EBT and since expenses reduce taxes paid our $200 decrease in EBT is $120 [200*(1-.4)].
NI is down $120, but the creation of the $200 warranty liability becomes a source of cash (think of it as cash we owe but don't have to pay back yet).
Net Change in cash of +$80. With L (warranty liability $+200)+ SE (Retained Earnings -$20) changing by +$80

Oct 6, 2017

levered or unlevered fcf?

Oct 6, 2017

Cowboy it with EBITDA - CapEx, admittedly not a good interview answer

Dec 14, 2017

Ive seen so many variations to finding free cash flow. Ive even seen research reports from different firms covering the same compay yet both have different free cash flows.

Ive seen change in networking capital included, as well as not included.

Is there a 'right way to do it', or is it ambiguous ?

Feb 8, 2019

Finding cash flow from EBITA has some specific steps which includes calculation of hypothetical tax bill and then deduction of the hypothetical tax bill from EBIT and then you get your net income number which can determine your cash flow. My uncle with steps calculated his cash flow and then realized that he was in a nee of immediate cash flow. Then he trusted Prestige Capital Corporation as his financial advisor and helper. Various services such as credit protection, dip financing are also provided by the company.

Feb 8, 2019

Hope it helps you.

May 21, 2019

Question on this for all those much smarter than me. If I take the below:

EBIT
Plus D&A
Less: Taxes
Less: Capex
Chg Working Cap
Free Cash Flow

Given that the taxes were calculated off of EBT which includes interest expense, is that correct or does it need to be adjusted?

May 21, 2019

We calculate taxes off EBIT in this case, not from EBT. This overstates the actual tax we pay because as you said it is calculated off EBT. But we reflect the tax shield in the cost of debt.

May 21, 2019

So it should be

EBIT
Plus D&A
Less: Taxes= EBIT * tax rate
Less: Capex
Chg Working Cap
Free Cash Flow

May 21, 2019

This is actually free cash flow to the firm. So it is yet to be distributed to equity and debt investors, that's why we exclude interest

May 22, 2019

Any chance you or someone can explain better why you calculate taxes off of EBIT and not EBT? Thanks

May 22, 2019
Comment
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May 31, 2019