In a recent article in Bank News, Scheller professor Chuck Mulford highlights alternate ways to measure cash flow outside of the traditional earnings before interest, taxes, depreciation, and amortization (EBITDA) for underwriting decision making. He suggests supplementing with EBITDA with free cash flow for a true evaluation of a firm’s cash flow.
He notes that the problem with EBITDA, unlike more sophisticated measures of cash flow, is that it does not take into account changes in working capital balances. A company may be generating ample amounts of EBITDA, but because of growing accounts receivable or inventory balances, for example, it may not be generating any actual cash flow that can be used to service debt.
He notes two reasons for implementing free cash flow as a supplement to EBITDA: for its ease of calculating real cash flow and not just an earnings metric and because it is measured after capital expenditures.
Read the full article here.