UNDERSTANDING

EBITDA & FREE CASH FLOW

CORPORATE HUMAN RESOURCEMarch 2008

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What is EBITDA?

• EBITDA is an acronym that stands for

E arningsB eforeI nterestT axD epreciation andA mortization

• EBITDA is also known as operating cash flow

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Why use EBITDA?

EBITDA = REVENUE - OPERATING EXPENSES

Revenue

Cash operating expenses

EBITDA

-

=

Revenue is the amount of money that is brought into a company by its business activities Revenue is calculated by multiplying the price at which goods or services are sold by the number of units or amount sold

The essential things that a company must pay for in order to maintain business, e.g. payment of employees' wages and funds allocated toward R&D

EBITDA is a good metric to evaluate profitability, but not cash flow. EBITDA also leaves out the cash required to fund working capital and the replacement of old equipment, which can be significant.

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Why use EBITDA?

EBITDA = REVENUE - OPERATING EXPENSES

Revenue

Cash operating expenses

EBITDA

-

=

Revenue

Cash operating expenses

NET INCOME

-

=

Interest Expense

Tax Provision

--

Depreciation expense-Non Operating

Income & Expenses

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Some shortcomings of EBITDA

• Does not truly represent operating cash flow as it is based on accrual accounting. (Revenue and expense are recognised when they occur, not when cash is actually spent or received)

• EBITDA does not take into account Capital costs, as depreciation is excluded.

• Does not take into account cash for working capital

• Does not take into account debt repayment and other fixed expenses

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Free Cash Flow (FCF)

Free Cash Flow is a measure of financial performance calculated as :

FCF = Operating Cash Flow - Capital Expenditures.

Free cash flow (FCF) represents the cash that a company is able to generate after laying out the money required to maintain or expand its asset base. 

Free cash flow is important because it allows a company to pursue opportunities that enhance shareholder value. Without cash, it's tough to develop new products, make acquisitions, pay dividends and reduce debt. FCF is calculated as:

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Free Cash Flow

FCF = Operating Cash Flow - Capital Expenditures.

EBITDA – Taxes – Increase in Net working capital - Capital Expenses

- Other Operating Investments

= Free Cash Flow

FCF represents the cash that we are able to generate after laying out the money required to maintain or expand its asset base.

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Differences between EBITDA & FCF

Revenue

Cash operating expenses

EBITDA

-

=

EBITDA

Revenue

Cash operating expenses

Net Income

-

=

NET INCOME

Increase in net Working capital

Interest Expense

Tax Provision

-

--

Revenue

Cash operating expenses

Capital Expenses

-

=

FREE CASH FLOW

Taxes--

Depreciation expense-

Free Cash Flow

= EBITDA

Other operating Investments

-

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Drivers of EBITDA

EBITDA

Operating Expenses

Revenue

-Volume

Cost of Goods Sold

SG&A

Price

Raw Materials

Labor

Other

Salaries of, non salespersonnel

Direct selling expenses

Indirect Selling expenses

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Drivers of Free Cash Flow

Free Cash Flow

Raw Materials

Labor

OtherOperating Expenses

Volume

COGS

SG&A

PriceRevenue

Salaries

Direct expenses

Indirect expensesInventory

Plant & Equipment

Receivables

Good Will

Intangibles

Payables

Property

Taxes

Capital Expenses

Increase in netWorking Capital

Other operating Investment

EBITDA

----

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How you can Increase EBITDA & Free Cash Flow

Increase EBITDA& FCF

Increase EBITDA& FCF

Increase RevenueIncrease Revenue

Reduce CostsReduce Costs

Improve Capital

Efficiency

Improve Capital

Efficiency

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Improve Strategic Planning and Demand ManagementImprove Strategic Planning and Demand Management

Improve Product Quality and ConsistencyImprove Product Quality and Consistency

Innovation & Faster Time-To-MarketInnovation & Faster Time-To-Market

Improve Manufacturing ResponsivenessImprove Manufacturing Responsiveness

Improve Customer ResponsivenessImprove Customer Responsiveness

Increase Throughput and Reduce DowntimeIncrease Throughput and Reduce Downtime

Increase VolumeIncrease Volume

Increase Market ShareIncrease Market Share

Increase Average Sales Price

Increase Average Sales Price

Increase EBITDA

& FCF

Increase EBITDA

& FCF

Increase RevenueIncrease Revenue

Reduce Costs

Reduce Costs

Improve Capital

Efficiency

Improve Capital

Efficiency

How you can increase EBITDA & Free Cash Flow

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Increase EBITDA & FCF

Increase EBITDA & FCF

Increase RevenueIncrease Revenue

Reduce Costs

Reduce Costs

Improve Capital

Efficiency

Improve Capital

Efficiency

Reduce Raw Material CostsReduce Raw Material Costs

Reduce Distribution CostsReduce Distribution Costs

Reduce SG&A CostsReduce SG&A Costs

Reduce Inventory Carrying Cost Reduce Inventory Carrying Cost

Reduce Energy CostReduce Energy Cost

Reduce Capital CostReduce Capital Cost

Reduce Variable CostReduce Variable Cost

Reduce Fixed CostReduce Fixed Cost

Reduce Capital CostReduce Capital Cost

How to you can increase EBITDA & Free Cash Flow

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Increase EBITDA & FCF

Increase EBITDA & FCF

Increase RevenueIncrease Revenue

Reduce Costs

Reduce Costs

Improve Capital

Efficiency

Improve Capital

Efficiency

Rationalize ManufacturingRationalize Manufacturing

Optimize InventoryOptimize Inventory

Reduce Capital CostReduce Capital Cost

Reduce Cycle TimeReduce Cycle Time

Optimize Fixed Asset Utilization

Optimize Fixed Asset Utilization

Reduce Cash Operating CycleReduce Cash

Operating Cycle

How you can increase EBITDA & Free Cash Flow

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Increase EBITDA

& FCF

Increase EBITDA

& FCF

Increase RevenueIncrease Revenue

Reduce Costs

Reduce Costs

Improve Capital

Efficiency

Improve Capital

Efficiency

Reduce Raw Material CostsReduce Raw Material Costs

Reduce Distribution CostsReduce Distribution Costs

Reduce SG&A CostsReduce SG&A Costs

Reduce Inventory Carrying Cost Reduce Inventory Carrying Cost

Reduce Energy CostReduce Energy Cost

Reduce Capital CostReduce Capital Cost

Reduce Variable CostReduce Variable Cost

Reduce Fixed CostReduce Fixed Cost

Reduce Capital CostReduce Capital Cost

Rationalize ManufacturingRationalize Manufacturing

Optimize InventoryOptimize Inventory

Reduce Capital CostReduce Capital Cost

Reduce Cycle TimeReduce Cycle Time

Optimize Fixed Asset Utilization

Optimize Fixed Asset Utilization

Reduce Cash Operating CycleReduce Cash Operating Cycle

Increase VolumeIncrease Volume

Increase Market ShareIncrease Market Share

Increase Average Sales Price

Increase Average Sales Price

Improve Strategic Planning and Demand ManagementImprove Strategic Planning and Demand Management

Improve Product Quality and ConsistencyImprove Product Quality and Consistency

Innovation & Faster Time-To-MarketInnovation & Faster Time-To-Market

Improve Manufacturing ResponsivenessImprove Manufacturing Responsiveness

Improve Customer ResponsivenessImprove Customer Responsiveness

Increase Throughput and Reduce DowntimeIncrease Throughput and Reduce Downtime

How you can increase EBITDA & Free Cash Flow