It's All About EBITDA (Duh!)

Cash Flow Is the Key Metric

EBITDA is the true measure of cash flow in a company. For those of you who like mathematical formulas, think about it like this:

EBITDA = Revenue – Expenses (excluding taxes, interest, depreciation, amortization).

In other words, EBITDA is the shorthand method for measuring operating cash flow and is the best measure of recurring value generation. It’s like watching your personal checkbook: You see what’s coming in, what’s going out, and what you need to operate in the near-term future.

Managing on the basis of EBITDA rather than the profit-and-loss statements eliminates the effects of financing, accounting rules, and all the other smoke and mirrors that look good on paper but get in the way of getting a real picture of the financial health of your company. If the accountant I mentioned previously had been measuring EBITDA in addition to profit, he would have been able to see the future trouble his company was heading toward well before it hit the wall.

Bear in mind that the “D” and “A” in EBITDA are non-cash expenses, so many companies just use EBIT to measure cash. It also leaves out items such as debt payments and other fixed expenses, cash required for working capital, and capital expenditures. I recognize that some people believe that a better method for measuring cash flow may be a free–cash flow model, which is simply cash from operations minus capital expenditures. Free cash flow captures the items EBITDA leaves out: receivables, inventory, and capital expenditures such as property and equipment. However, free cash flow doesn’t count the cost of debt either.

My point is not to debate the respective merits of the use of EBITDA, EBIT, free cash flow, or some other method. Rather, it is to drive home the fact that these metrics will be more accurate and meaningful to you than using profit-and-loss statements, which are not giving you the complete picture of your company’s health. Measuring the cash your company is generating will give you a better sense of the future state of your business before you have to pay creditors, Uncle Sam, et cetera.

Besides measuring cash flow, it is also critical that your company project its cash flow into the near future for about 13 weeks. I can’t begin to tell you how many companies do not have projected–cash flow statements. How can you possibly manage a business if you don’t know how much cash is coming in, how much you need to pay out, how much you have left over, or how much you need to borrow? If your company isn’t doing this on a rolling weekly basis, it seems like you are driving your corporate car with blinders on.