EBTIDA to Free Cash Flow Formula

In this video we are going to be talking about converting EBITDA and EBIT to free cash flow to the firm and free cash flow to equity. But first, why would we do that?
Understanding how businesses generate cash flow should be a top priority for any aspiring financial professional or investor. And EBITDA and EBIT are constantly referenced in valuation exercises.
EBITDA is one of the most commonly used metrics to arrive at valuation, especially in the context of private equity transactions. And it is frequently cited as a proxy for cash flow, which is dangerous if you don’t understand what it means.
We’re going to be using an Excel template, which has a three-statement model on the left-hand side and calculations for free cash flow on the right-hand side, to better understand the relationship between these metrics. I think these formulas are too frequently provided without explanations, so were going to fix that.
That said, if all you’re looking for is the formulas, you can download the template at this link:
www.asimplemod...

[@paulb2022]

Very useful video and at the heart of investing.

[@ASimpleModel]

Thank you! I've had this conversation with many with business owners, especially those carrying heavy debt loads or building excess WC. Most stay focused on cash flow, but those that really heavily on income statement performance overlook opportunities to improve FCF.

[@paulb2022]

@@ASimpleModel good point. What's an example of a 'miss' to improve cash by being too focussed on PnL only?

[@ASimpleModel]

@@paulb2022 Strong focus on working capital. You can have nearly identical income statements (down to EBIT because debt load will appear in the form of interest expense) and wildly different cash flow. It's one reason the Q of E is so important in private equity transactions. I made a video that exaggerates the difference to make a similar point: ruclips.net/video/sDx49v2OYWQ/видео.html (the PE Training materials on ASM get very detailed on this point)

[@EnigmaticViews]

Hi Peter, great video! Quick question, for the interest expense*(1-tax rate), given that the amount of allowable business interest deduction is effectively capped at 30% of EBIT, would this impact the calculation of FCF?

[@ASimpleModel]

Thanks! And great question! Not in this model because it's below the threshold (assume that's not what you are asking but just in case). If you were looking at a company's tax books, and interest exceeded 30% of adjusted taxable income (ATI, EBIT for tax years after 2021), then you're correct that the shield would only apply to the 30%. Cruel coincidence that this rolled out after years of ZIRP policy and just before interest rates spiked!

[@deeJayThraxx]

🎉