What Is the Difference between EBITDA and Cash Flow from Operations?

I just picked up the Pershing Square Value and Philanthropy Challenge (held on April 24, 2013) where I left off months ago.  It’s not the only catching up I have to do, but here is why I am sharing this with you.

At 01:16:00, Bill Ackman asks a seemingly simple question that throws the guys presenting Hertz (HTZ) off balance.

What’s the difference between EBITDA and cash flow from operations?

I felt bad for the guys.  Obviously, they spent a lot of time preparing for their presentation and did a whole lot of research on the company and the industry.

I don’t know much about Hertz and I couldn’t see their EBITDA number and how it was derived.  But, here is the difference between EBITDA and CFO.

EBITDA = EBIT + DA

EBIT is often equated with operating profit, which may or may not be true.  A gap can open up if non-operating income/loss is present (usually impairments and gains/losses on sale of PP&E and investments).  EBIT includes non-operating income/loss while operating profit doesn’t.

DA is depreciation and amortization.  Nothing special there.

CFO = E + DA – Increase in current assets (excluding cash) + Increase in current liabilities (excluding debt) + Other non-cash items

E is earnings or net income.

DA is the same DA from EBITDA.

Increase in non-cash current assets is usually the new cash tied up in accounts receivable and inventories.  On the opposite side of the balance sheet, the increase in non-debt current liabilities is usually the new cash freed up by not paying suppliers immediately (accounts payable) and by getting paid before delivering the product/service you are selling (deferred revenue).  Netted the changes in current assets and current liabilities represent the change in working capital.

Other non-cash items, besides depreciation and amortization, may include stock-based compensation and the abovementioned gains/losses.

When you put these two equations next to each other, the differences become pretty obvious.  The major difference is the change in net working capital.  It is present in CFO and absent from EBITDA.

So, for a company building up inventories (not financed by its suppliers) and extending more credit to its customers, as is usually the case with growing companies, CFO will be lower than EBITDA.

Which measure to use?

A lot of times there won’t be a material difference.  As usual, just use the measures you are comfortable with and make sure you apply them consistently.  The idea of both CFO and EBITDA is to give an idea about the operations of the business regardless of capital structure and tax regime.