EBITDA vs Cash Flow

EBITDA's neutrality is also its weakness — it leaves out three genuine cash outflows. (1) CAPEX: capital expenditures are how a company maintains and grows its asset base; EBITDA adds back depreciation (the accounting echo of past capex) without subtracting the actual cash spent on new assets. (2) WORKING CAPITAL: growth ties up cash in receivables and inventory; EBITDA ignores this entirely. (3) CASH TAXES: EBITDA is pre-tax, but taxes are a real cash cost. A company can post strong EBITDA and still burn cash if its capex, working-capital build, and tax bill exceed it.

The cleanest way to see the difference is the bridge from EBITDA to unlevered free cash flow: start with EBITDA, subtract cash taxes (often computed as EBIT × tax rate, so you also subtract D&A then add it back), subtract capex, and subtract the increase in net working capital. What remains is the cash available to all capital providers — the figure you actually discount in a discounted cash flow. EBITDA is the starting line of this bridge, not the finish. The difference between the two is precisely capex + working capital + cash taxes.

For an asset-light software business, EBITDA and free cash flow are close — minimal capex, modest working capital. For a capital-intensive business (telecom, manufacturing, airlines), EBITDA dramatically overstates cash generation because capex and depreciation are huge. This is the central critique of EBITDA, famously summarized as 'EBITDA pretends capex doesn't exist.' In LBO analysis sponsors live by EBITDA for debt sizing but model free cash flow for whether the company can actually service that debt. The lesson: use EBITDA to compare and to size leverage, but use free cash flow to judge whether a business truly funds itself.