RMA PAPER WRITING CONTEST 2002 1ST PLACE WINNER

Cash Flow or EBITDA?

Can’t We Have Both?

by John Cassis

I
t’s possible to reconcile EBITDA and cash flow, Cassis contends.
This article first explores some of the published debate on
EBITDA and cash flow, next reviews EBITDA and cash flow
components and what each one offers, and then repositions those
components to reconcile EBITDA and cash flow and improve their
usefulness to lenders and analysts.

T
he debate over using whenever possible. The two The subject of operating cash
either EBITDA (earn- methods can produce frustrating- flow and the drawbacks of EBIT-
ings before interest, ly divergent results. But it is pos- DA is not new. In the March 1993
taxes, depreciation, and amortiza- sible to reconcile EBITDA and Journal of Accountancy, Don E.
tion) or cash flow in measuring cash flow. Giacomino and David E. Mielke
return or repayment ability proposed nine ratios for financial
reminds me of a line from one of Cash Flow: There’s No analysis based on cash from opera-
my favorite movies, Trading Places. Accounting for Good Definitions tions.1 In the July/August 2001
At the end of the movie, when Cash flow is a rather broad RMA Journal, Frank DiLorenzo
the main cast of characters is term. It has been used to refer to addressed the impact of balance
sprawled along a secluded tropical net cash after operations (NCAO) sheet changes on operating cash
beach, the ex-servant Coleman as calculated in RMA’s Uniform flow and repayment analysis,
asks his lady friend whether she Credit Analysis® cash flow state- emphasizing the need to under-
would like to dine on “the lobster ment. It also has been used to stand the extent to which the
or the cracked crab.” Her refer to operating cash flow as cal- changes are recurring and con-
response: “Can’t we have both?” culated by the FASB 95 cash flow trolled by the company.2
Well, over the years, I’ve had statement. This article considers Several more papers have
to “eat” both EBITDA and oper- cash flow to refer to the entire warned about the dangers of using
ating cash flow arguments. As col- FASB 95 cash flow statement’s EBITDA. Moody’s Investors
leagues have debated EBITDA operating, investing, and financ- Service issued a 24-page special
versus cash flow, every such dis- ing activities, paying closest atten- comment in mid-2000, presenting
cussion has ended with the com- tion to operating cash flow and its 10 critical failings of EBITDA.
promise that each method is respective components but ulti- Some of these failings include
important in its own right and mately covering all portions of the ignoring changes in working capi-
that both should be employed cash flow statement. tal, ignoring the quality of earn-
© 2002 by RMA. Cassis is the senior portfolio specialist at SunTrust Bank, Fort Lauderdale, Florida. This article received the
first-place award in RMA’s 2002 Paper Writing Competition. It is the author’s fourth article to appear in The RMA Journal.

26 The RMA Journal December 2002 - January 2003

 Cash Flow o r EBITDA?
Can’t We Have Both?

ings, and ignoring unique attrib-

Table 1
utes of many industries.3 Dev Factors to Be Considered when Reconciling EBITDA and Cash Flow
Strischek recently described sev-
eral problems with EBITDA and Calculated Factors
proposed some alternatives to Tax obligations.
EBITDA-based loan covenants. Capex replenishment (some adjustment may be necessary).
Dividend payments.
EBITDA drawbacks included
Changes in working capital.
ignoring a company’s tax obliga-
tion, ignoring capex replenish- User-Defined Factors
ment, and ignoring dividend pay- Extent to which balance sheet changes are recurring.
ments. Mr. Strischek’s proposals Extent to which balance sheet changes are controlled by the company.
Quality of earnings.
included adjusting EBITDA to
Unique attributes of different industries.
free cash flow, and applying the
Uniform Credit Analysis’s NCAO
1. Net EBITDA: Begin with net those expenses were paid during
and cash after debt amortization
income straight from the the period being analyzed.
(CADA) to debt service.4 Another
income statement and add Ignoring this timing difference
argument in favor of a free cash
back interest expense, taxes, leads to a pure measure of benefit
flow method for measuring debt
depreciation, and amortization. derived per effort expended.
repayment ability appeared in the
2. Operating EBITDA: Begin Operating EBITDA tells the ana-
March 2002 issue of The RMA
with net operating profit and lyst just how efficient the compa-
Journal.5
add back depreciation and ny was at utilizing its resources to
Table 1 summarizes the fac-
amortization. turn a profit, rather than how effi-
tors influencing cash flow and
The second way bypasses taxes cient the company was at collect-
EBITDA discussed in those arti-
and interest expense because ing from customers and paying its
cles. These factors are separated
both are implicitly considered to suppliers. That is the philosophi-
into calculated factors and user-
be nonoperating; by default, it also cal benefit of an accrual method
defined factors. Calculated factors
ignores any extraordinary items, over a cash-only method.
are already calculated in the FASB
interest income, gains and losses, So operating EBITDA meas-
95 cash flow statement, and user-
and other nonoperating income ures the results of a company’s
defined factors require the user’s
and expenses. performance—its success as a
judgment to estimate them based
Operating EBITDA is also going concern. However, this
on research and analysis.
equal to revenues minus operat- powerful EBITDA measure can
ing expenses except for deprecia- be further enhanced for maximum
EBITDA: It Doesn’t Add Up to
tion and amortization. When the analytical value. Fortunately,
Cash Flow
income statement is accrual based operating EBITDA is actually the
It’s clear that using unadjust-
and/or is prepared in accordance foundation of the operating sec-
ed EBITDA, which excludes all
with generally accepted account- tion of the cash flow statement.
of the factors shown in Table 1, is
ing principles (GAAP), operating
a dangerous proposition. Further-
EBITDA tells the user how much Using the Cash Flow State-
more, there is a distinct scarcity of
out-of-pocket expense had to be ment—Operating Activities
articles singing the praises of
incurred to generate a certain In addition to operating
EBITDA. Nevertheless, the
level of revenue. Any noncash EBITDA, operating cash flow also
widespread use of EBITDA by
expenses and expenses not reflects interest, tax expense, and
corporate lenders and securities
required to generate those rev- nonoperating income and expens-
analysts suggests it serves some
enues are excluded. Also not con- es. Consider the hypothetical
useful purpose.
sidered is whether or those rev- operating section of a FASB 95
There are two common ways
enues were collected and whether cash flow statement and further
to calculate EBITDA:

27
 Cash Flow o r EBITDA?
Can’t We Have Both?

breakout of net income shown in items are accounted for in another tal need, other operating balance
Table 2. part of the FASB 95 cash flow sheet items, and income state-
Clearly, the entire income statement. Also evident in Table ment debt service, the end result
statement is embedded within the 3 is that, when combining net equals cash from operations.
first line of the operating cash flow EBITDA with the working capi-
section. Although some adjust-
ments must be made to arrive at Table 2
cash from operations, all compo- Hypothetical Operating Cash Flow Section with Income
nents of net income are nonethe- Statement Detail (in thousands)
less accounted for. Furthermore,
Operating Cash Flow Income Statement
since we know that EBITDA,
Net Income 100 Revenue 1,500
whether net or operating, is
Plus Depreciation 50 Less: Cost of Sales ( 800)
derived entirely from the income Plus Amortization 20 Less: Rent ( 50)
statement, it follows that EBIT- Less: Capital Gains ( 30) Less: Payroll ( 250)
DA must also be embedded with- Change in Accounts Receivable ( 250) Less: Deprec. & Amort ( 70)
in the operating cash flow section. Change in Inventory ( 100) Less: Other Op. Expenses ( 100)
Let’s now recast the income Change in Accounts Payable 150 Net Operating Profit 230
statement and the cash flow state- Change in Payroll Payable 20 Less: Interest Expense ( 90)
ment to group their line items Change in Prepaids ( 10) Less: Income Taxes ( 50)
into more meaningful components Change in Income Taxes Payable ( 20) Plus: Capital Gain 30
(see Table 3). When isolating Change in Other Taxes Payable 30 Less: Other Expenses ( 20)
operating EBITDA from operat- Cash From Operations ( 40) Net Income 100
ing cash flow, it becomes appar-
Table 3
ent that additional logical group-
Logical Grouping of Income Statement and
ings of cash flow items are possi- Operating Cash Flow Items (in thousands)
ble. Subtracting nonoperating
out-of-pocket income statement Operating EBITDA Net Working Capital Need
items—except for interest Revenue 1,500 Change in Accounts Rec. ( 250)
expense—from operating EBIT- Less: Cost of Sales ( 800) Change in Inventory ( 100)
Less: Rent ( 50) Change in Accounts Payables 150
DA results in net EBITDA.
Less: Payroll ( 250) Net Working Cap. Need ( 200)
Next, by reducing this number by
Less: Other Op. Expenses ( 100)
out-of-pocket income taxes, one
Operating EBITDA 300
of EBITDA’s failings, we get net
Other Operating Balance Sheet Items
EBIDA. Furthermore, we can see
Nonoperating Items Change in Payroll Payable 20
that the working capital require- Other Expenses ( 20) Change in Prepaids ( 10)
ment—the absence of which was Change in Other Taxes Payables 30
also mentioned as a failing of Net EBITDA 280 Net Change in Other Op. 40
EBITDA—has been isolated, as
Income Taxes Paid Income Statement Debt Service
has interest expense (a compo-
Income Taxes ( 50) Interest Expense ( 90)
nent of debt service that the UCA
Change in Income Taxes Payables ( 20)
cash flow inherently isolates) and
Income Taxes Paid ( 70)
changes in other operating bal-
ance sheet items. Note that while Net EBIDA 210
depreciation, amortization, and Reconciliation
capital gains were accounted for Net EBIDA 210
in the income statement, they Less: Net Working Capital Need (200)
Plus: Net Change in Other Op. Items 40
were removed from the operating
Less: Income Stmt. Debt Service ( 90)
cash flow section because these Cash From Operations ( 40)

28
 Cash Flow o r EBITDA?
Can’t We Have Both?

The Rest of the Cash Flow statement generally accounts for cash flow in Table 4 reflects fixed
Statement the changes in nonoperating items asset sales separate from fixed
While EBITDA and operat- on the asset side of the balance asset purchases, but netting them
ing cash flow have received the sheet. A typical investing section is is the more common presentation.
greatest attention to this point, displayed in Table 4. Table 4 also shows the acquisition
there are two more very funda- Another noted problem with of $120,000 in goodwill. Some
mental sections of the FASB 95 EBITDA is its failure to account analysts consider goodwill acquisi-
cash flow statement—investing for capex requirements. Capex is tion to be capex while others
and financing activities. the fixed—and sometimes intan- don’t. We will consider goodwill
gible—asset purchases of a com- acquisition to be capex on the
The investing section reports
pany. Capex requirements can fur- basis that goodwill is a permanent,
the company’s capital expendi-
ther be separated into a growth long-term asset regardless of the
tures, subsidiary investments,
component and a recurring com- desirability of its intrinsic value.
lending, and other mostly outflow
ponent.6 The recurring compo- If lending money is not the
activities. Put another way, the
nent is one that occurs regularly company’s primary business, then
investing section of the cash flow
just to maintain the current that activity will appear in the
level of revenues and thus investing section instead of the
Table 4
should be covered by the operating section. Similarly, if the
Hypothetical Investing Cash Flow
company’s current cash flow. company is not an investment com-
Section (in thousands)
Growth capex exists only pany that derives its operating rev-
Sale of Fixed Assets 40 when a company is expand- enue from the income of subsidiary
Purchase of Fixed Assets ( 80) ing, and it can prudently be companies, then income from sub-
Goodwill Acquired (120) financed and repaid over sidiary, or investment in subsidiary
Change in Loan Receivable ( 50)
time instead of necessarily for a cash use, will appear in the
Change in Other Nonoperating Assets ( 20)
Investment in Subsidiary 10 being covered by cash flow investing section. Furthermore, it is
Net Cash Used in Investing Activities (220) in the period incurred. The possible to separate any positive
cash flow from subsidiaries, such as
Table 5 distributions to the parent compa-
Return on Capital versus Return of Capital (in thousands) ny, into two components: return on
investment and return of invest-
Case 1 Case 2 Case 3 Case 4
ment. This is an important distinc-
Beginning Balance: Investment in Subsidiary 50 50 50 50
tion where subsidiary accounting
Plus: Income from Subsidiary 30 30 30 30
Less: Ending Balance: Investment in Subsidiary (80) (60) (40) (90)
exists because return on invest-
Cash from (to) Subsidiary 0 20 40 (10) ment can be considered a compo-
nent of net EBITDA as an “in-the-
Case 1—No distribution is paid by the subsidiary. pocket” nonoperating income
Case 2—A distribution of $20,000 is paid by the subsidiary, but there is growth in the balance statement activity. In contrast,
sheet item "investment in subsidiary," so no capital has been distributed. The full distribution is return of investment represents a
a return on investment. return of capital best matched
Case 3—A distribution of $40,000 is paid by the subsidiary. Since the "investment in sub- against the investment of capital
sidiary" item declined during a period in which the subsidiary's income was positive, the amount
into the subsidiary. Several return-
of this decline represents return of capital. In this case, return of investment = $10,000 (the end-
ing balance of investment in subsidiary less the beginning balance), and return on investment =
on-capital and return-of-capital sce-
$30,000. The return on investment can be considered analogous to other nonoperating income narios are shown in Table 5.
statement activities that were a true source of cash. Finally, other activities repre-
Case 4—A distribution may or may not have been made (enough information has not been pro- senting changes in nonoperating
vided to determine for certain). Should any distributions have actually been made, the parent balance sheet items are reflected
company nonetheless invested $10,000 above any distribution back into the subsidiary. In this in the investing section. Depend-
case, the whole $10,000 can be considered an investing activity.
ing on the cash flow statement,

29
 Cash Flow o r EBITDA?
Can’t We Have Both?

these items may or may not be tion to understand all of a compa- recognition practices, and partial-
shown in detail. Furthermore, ny’s borrowings and repayments. year results are common examples
certain such items—such as Frequently debt repayments are of the user-defined EBITDA
advances to employees—may be netted against borrowings. shortfalls revealed earlier in Table
placed in the investing section by However, where this distinguish- 1. If a user-defined factor exists
one accountant and in the operat- ing information exists, the financial but is not addressed, it can render
ing section by another. The finan- statement user should make the not only EBITDA dangerously
cial statement user must make extra effort to draw the distinc- misleading but also cash flow.
sure that the cash flow figures are tions. If additional information Identifying and accounting
properly analyzed for maximum existed about the data in Table 7, a for these situations may take pure
cash flow quality. suggested logical separation of the detective work from the lender/
After using some assumptions financing activities is shown in analyst. When identified, such
and grouping line items into logi- Table 8. The sum of the separate specific information must be
cal components, the investing financing activities equals net cash quantified, and the analyst should
cash flow shown in Table 4 might provided by financing activities as adjust EBITDA and cash flow
be separated into the components shown in the FASB 95 statement. accordingly. If EBITDA or operat-
shown in Table 6. Once again, it
becomes apparent that the group- User-defined
ings total the net cash flow from Adjustments Table 6
investing activities. While the Logical Grouping of Hypothetical Investing
three sections of Activities Shown in Table 4 (in thousands)
The financing section
the cash flow Mandatory Capital Expenditures (Net) ( 20)
accounts for all debt borrowings
statement will Growth Capital Expenditures (Net) ( 140)
and repayments as well as equity
provide all of Return on Investment in Subsidiary 5
issuances and dividends. Return of Investment in Subsidiary 5
the calculated
Financing activities can generally Other Investing Activities (Net) ( 70)
factors whose
be thought of as the nonoperating Net Cash Used in Investing Activities ( 220)
absences were
debt and equity components of
shortcomings of Table 7
the balance sheet. Financing
EBITDA, what Hypothetical Financing Cash Flow Section
activities typically represent the
about the user- (in thousands)
funding sources of investing and
defined factors?
operating activities. A typical Cash Provided by Borrowings 100
Almost every
FASB 95 financing section is Net Cash Provided by Equity Offering 40
company has
shown in Table 7. Dividends Declared and Paid ( 20)
special circum- Net Cash Provided by Financing Activities 120
While the Uniform Credit
stances of one
Analysis (UCA) cash flow draws
type or another Table 8
some valuable distinctions here,
that are not self- Suggested Logical Separation of Hypothetical
such as grouping dividends and
evident in Financing Activities Shown in Table 7
scheduled principal reductions into
EBITDA or (in thousands)
a separate section called debt
even in the cash
amortization, the FASB 95 cash Line of Credit Borrowings 150
flows. Non-
flow does not. Recall that failing to Scheduled Principal Repayment ( 100)
recurring Additional Term Borrowings 50
account for dividends is another
income and Cash Provided by Borrowings 100
EBITDA shortcoming. Also,
expenses, build- Additional Stock Issued 90
depending on the accountant or
ing up of inven- Treasury Stock Purchased ( 50)
the inputs, sometimes neither the
tory for a special Cash Provided by Equity Offering 40
FASB 95 cash flow nor the UCA
order, question- Dividends Declared and Paid ( 20)
cash flow provides enough separa-
able revenue- Net Cash Provided by Financing Activities 120

30 The RMA Journal December 2002 - January 2003

 Cash Flow o r EBITDA?
Can’t We Have Both?

ing cash flow is being reduced by The Matched-Allocation ing activities but which make more
the cost of a $50,000 judgment— Performance Statement sense as operating items are
which, by all determination, was a Table 9 illustrates the cash matched to the related operating
fluke—then this amount should flow-EBITDA reconciliation—a items for a more meaningful analy-
be added back in the analysis to cash flow statement that groups sis. The performance statement
normalize the cash flow. all cash flow activities by the con- assumes that any financings direct-
It would be well beyond the ventional FASB 95 method, pres- ly matched to related uses are off-
scope of this article to isolate and ents EBITDA as a stand-alone set before any surplus or deficit is
address all the many nonquantita- cash flow measure, and shows made available to other sections of
tive circumstances that can ran- adjustments to reflect all calculat- the cash flow statement. While
domly impact EBITDA and cash ed and user-defined shortcomings some user discretion is necessary
flow. The financial statement user shown in Table 1. Furthermore, to group sources and uses, the
must determine what adjustments users accustomed to RMA’s UCA lender/analyst usually has access to
are appropriate on a case-by-case cash flow statement will find the corporate officers for any miss-
basis. This adjustment process is Table 9 very familiar. This new ing information.
the final critical component to presentation has been designed to Let’s discuss the features and
achieving the goal set at the measure a company’s ability to layout of this statement. The per-
beginning of this article—to rec- service its debt obligations. formance statement shown in
oncile EBITDA and cash flow. By The term matched allocation is Table 9 has been derived from the
grouping the different sections of derived from the fact that sources hypothetical groupings explained
the cash flow statement into logi- of cash are matched to their related earlier in this article. The perform-
cal, analytical components, we uses. For example, a revolving line ance statement is separated into six
have all the information we need of credit that was used to support sections moving vertically. The first
to complete the task. Let’s call growth in receivables and invento- three sections are operating, invest-
this reconciliation the Matched- ry is grouped with those operating ing, and financing items. The
Allocation Performance Statement balance sheet items. Also, certain fourth section is titled “adjust-
(see Table 9). items initially classified as invest- ments” and is designed to accept

Table 9
The Matched-Allocation Performance Statement
(2001 in thousands)
Cash Income Earned > Expenses Incurred Net Working Investment Other Activities Traditional Cash Flow

Operating items Op EBITDA 300 Nonop inc (20) Cash taxes (70) Chg in NTAs (200) Chg in other op 40 Op cash flow 10
Op cash flow
before int exp 50

Cash return on Growth Other invest (70)

Investing items Recur capex (20) I-subs* 5 capex (140) Cash ret of I-subs* 5 Invest cash flow (220)
Financing items RLOC 150 Term debt 50 Stock issued, net 40
Other Fin cash flow 170
Adjustments

Totals 280 (15) (70) (50) (90)

Adjusted Net EBITDA 195 Adj Net working investment(140) Adj Other (30) 50
Adj Net EBITDA After Net WI 55 Net Cash Flow (40)

Repayment and Return Interest expense 40 40 40

Sched debt repymt 50 50 50
CF after debt Svc./DSC 105 2.17 X (35) 0.61X (40) 0.56 X
Dividends 20 20 20
CF After Dividends 85 (55) (60)
* I-subs = investment in subsidiaries

31
 Cash Flow o r EBITDA?
Can’t We Have Both?

input related to user-defined fac- treated like a nonoperating expense. In such a case, I
tors. The fifth section is a totals income statement item (similar to would use the adjustments
section to tally each column and set dividend received from a publicly row to deduct estimated tax
of columns. The sixth section is traded investment). Any financing underpayment or add back
credit specific and accounts for items known to have specifically estimated tax overpayment.
debt service and dividends, and supported these nonoperating When tabulated, the three
provides net cash flow and debt items would also be reflected in columns total adjusted net
service coverage calculations. this column. EBIDA. For those who want to
The performance statement is 3. Income taxes. The first row assess the company’s ability to
also separated into four sections is titled “cash taxes” and reflects earn an accrual profit from primary
moving horizontally. Most atten- the cash actually paid for income and ancillary business activities
tion will be given to these colum- taxes shown in the operating after the payment of taxes, a debt
nar groupings of data, as these are statement of a traditional FASB 95 service section is provided imme-
what distinguish this cash flow cash flow statement. This is the diately below. Cash flow after debt
statement. last column of the section because service and debt service coverage
both operating EBITDA and non- are also reflected. Thereafter, divi-
The first columnar section,
operating income and expenses dends are also deducted. Place-
“cash income earned in excess of
are used to calculate income ment of dividends beneath debt
expenses incurred,” has three
taxes. There are two important service is a function of payment
columns:
observations about this column: priorities. While a company might
1. Operating EBITDA (an
1) Subchapter-S corporations feel obligated to pay dividends to
operating item) on the first line,
and other pass-through com- support its market price, that same
less recurring capex (an invest-
panies are not obligated to company is more likely to suspend
ment item) on the second line,
pay income taxes and thus the dividend and use the cash
plus or minus any pertinent
would not reflect a number saved to service its debt obliga-
adjustments. Any financing items
here. Treatment of this matter tions. Cash flow after dividends is
specifically used to support either
is at the analyst’s discretion. reflected last.
operating EBITDA or recurring
My personal preference in Thus, the first columnar sec-
capex would also be placed in this
this case is to allow income tion has accounted for all but one
column on the rowed section
tax to be zero and to account of EBITDA’s failings shown in
titled “financing items.” The
for it in a global cash flow; Table 1. The fix for working capi-
subtotal of this column allows for
however, others may wish to tal changes is handled next.
consideration of five of EBITDA’s
estimate income tax at the
shortfalls shown in Table 1: capex The second columnar section,
corporate rate and include it
replenishment plus all user- “net working investment,” cap-
as an outflow in the adjust-
defined factors known to the tures growth in working capital
ments row.
lender/analyst. and fixed assets, as well as any
2) Subchapter-C corporations
2. Out-of-pocket nonoperating external financing supporting that
are often required to recog-
income statement items, other growth. This section has two
nize deferred tax assets, liabil-
than interest expense. The out-of- columns.
ities, income, and expenses
pocket qualifier indicates that cap- 1. The first column begins
for a variety of reasons. They
ital gains and losses are excluded. with the description “change in
sometimes also derive benefit
Items such as interest income and NTAs.” Net trading assets (or
in the current period from
extraordinary items would be NTAs) are defined as accounts
operating carryforwards on
reflected here. Return on invest- receivable, plus inventory, less
losses incurred in previous
ment in subsidiary appears in the accounts payable. These three
periods. As a result, total cash
investing row of this column. Here special accounts are isolated and
taxes paid may not be indica-
the cash return on investment is given specific attention because
tive of sustainable income tax

32 The RMA Journal December 2002 - January 2003

 Cash Flow o r EBITDA?
Can’t We Have Both?

of their overall importance rela- the obvious funding source. the financing section directly
tive to other operating balance • A company’s CFO frequent- beneath growth capex. However,
sheet items. Any loans used ly has a hand in the manage- if growth capex is not financed
specifically to finance NTAs, such ment of NTAs and supporting through external sources, then
as asset-based credit lines or floor- credit lines. Therefore, inclu- adjusted net EBIDA would be
plan lines, would appear in the sion of NTAs and related called upon for support just as it is
same column. Let’s discuss cer- financings in the measure of called upon to support NTA
tain issues related to NTAs: debt service coverage can growth in the absence of debt
• When a company’s sales are include cash movements that financing.
not growing, NTAs generally were made at the whim of The net working investment
should not grow either. They company management. (NWI) section ends with a subto-
may change due to changes in • NTAs can sometimes be a tal for each column, as well as a
time to pay or collect, but source of cash when a compa- total for NWI itself. For those
they generally will not be a ny’s sales are declining or who prefer to measure debt serv-
use of cash the way recurring when a company is taking ice coverage after net EBIDA has
capex would be even in a no- extended terms on its been applied to unfinanced NTA
sales-growth situation. payables. Conservative cash and capex growth, a grand total
• When a company’s sales are flow proponents take the for the first two columnar sections
growing or when net EBIDA position that positive cash is also shown. Cash flow after
is being used to repay trade flow from changes in NTAs debt service, debt service cover-
debt, NTAs generally are a should not be credited to net age, and dividends are also
cash use. Should the sales EBIDA when calculating reflected for this grand total.
growth be a one-time sales DSC. To the extent that such
The third columnar section is
growth, the change in NTAs changes are nonrecurring,
a “catch-all” section. Titled “other
will also represent a one-time they should be reflected in
activities,” it has just one column.
cash use, but a cash use the adjustments row.
The section begins with changes
nonetheless. As a result, many Otherwise, however, the
in operating balance sheet items
cash flow proponents believe matched-allocation cash flow
other than receivables, payables,
that growth in NTAs should is designed to give full credit
and inventory. Such changes, usu-
always be deducted from net when NTA changes result in
ally quite nominal, include accruals
EBIDA before calculating a source of cash. If this source
for payroll, other taxes, and pre-
debt service coverage. Still were manufactured by man-
paid expenses. This column also
other cash flow proponents agement to alleviate a nega-
lists other investing activities, such
believe that any specific tive net EBIDA, this situation
as loans advanced, investments in
financing used to support the would become apparent in
subsidiaries, and return of invest-
growth in NTAs should be the totals row.
ments in subsidiaries. Finally, any
credited against NTAs before 2. The second column begins
debt or equity financing either
taking the deduction against with the investing item “growth
specific to these items or not else-
net EBIDA. The matched- capex.” This item represents pur-
where classified would be shown
allocation performance state- chases of fixed assets and intangi-
in the financing row of the column.
ment assumes the latter: that bles to support the company’s
any specific borrowings used growth. These expenditures typi- The fourth columnar section
to support the growth in cally are the most significant uses is called “traditional cash flow”
NTAs are used to offset the of cash on the cash flow state- and contains two columns. The
cash use first. If the company ment. Consequently, these pur- first column is a depiction of the
does not have or does not chases are usually financed either subtotal for each section of the
qualify for revolving debt, through long-term debt or equity, FASB 95 cash flow statement,
then net EBIDA would be which would then be reflected in with a direct reconciliation to net

33
 Cash Flow o r EBITDA?
Can’t We Have Both?

cash flow. Some items shown reflects collateral-based lending complicated, modern-day financial
below the cash flow, such as divi- for the period, and hopefully statements.
dends and interest expense, are lenders will have advanced no The matched-allocation per-
transparently added back in calcu- more credit than was warranted by formance statement begins with
lating net cash from operations the additional NTAs and growth operating EBITDA and ends with
and net cash provided by financ- capex acquired. The other activi- cash flow. It is the author’s hope
ing activities. The second column ties section reflects such cash-on- that the columns in between have
is for the UCA cash flow user who hand-based activities as nominal married the two concepts in a use-
prefers operating cash flow before timing differences in the payment ful and understandable manner.
interest expense—synonymous of payroll and other expenses, as This new presentation should
with the UCA’s NCAO—as the well as loans to others and invest- allow the lender/analyst to have it
proper measure of debt service ments in subsidiaries and similar both ways now that we have rec-
coverage. The same debt service, transactions usually financed by a onciled their differences. Now all
debt service coverage, and divi- company’s cash on hand. They we have to do is find that seclud-
dend information shown else- could also legitimately be financed ed tropical beach! ❐
where are reflected here. by net cash flow remaining after
the first two columnar sections, or Contact Cassis by e-mail at
Some General Observations possibly by new equity, but prefer- john.cassis@suntrust.com for a com-
As we move further to the ably not by debt unless the debt plimentary blank copy of the perform-
right on the performance state- was seasonal/unsecured and ance statement in Excel format.
ment, each column becomes one specifically intended to cover tim-
more step removed from the first ing differences. Notes
1 Giacomino, Don E. and David E. Mielke, “Cash
column. Operating EBITDA (col- Flows: Another Approach to Ratio Analysis,”
Journal of Accountancy, March 1993, pp. 55-58.
umn one) and nonoperating Conclusion
income statement items (column The EBITDA-versus-cash 2 DiLorenzo, Frank, “Getting Behind the
Numbers,” The RMA Journal, July/August 2001,
two) are both available to pay flow debate will continue for a pp. 74-75.
taxes (column three). Any cash long time to come, because propo-
3 Stumpp, Pamela M., “Putting EBITDA in
remaining after the payment of nents of each have solid reasons, Perspective: Ten Critical Failings of EBITDA as the
taxes would then be used to sup- based on years of seasoned expe- Principal Determinant of Cash Flow,” Moody’s
Investors Service Global Credit Research Special
port NTA growth (column four) rience, for preferring one Comment, June 2000.
and fixed asset growth (column approach over the other.
4 Strischek, Dev, “E-B-I-T-D-A: It Doesn’t Spell
five), to the extent direct financ- Ultimately, what matters most is Cash Flow,” The RMA Journal, November 2001,
ing of these investments was not understanding a company’s per- pp. 30-39.
sufficient. Finally, any cash left formance and knowing how capa- 5 Zoeller, Mark J., “Free Cash Flow: Free to Do
over after that, plus any cash on ble it was, and will continue to be, What?” The RMA Journal, March 2002, pp. 34-
39.
hand, would be used to support in repaying its debt obligations
the timing of other expenses as and/or providing a return to its 6 Cassis, John, “Hide & Seek: There’s Hidden Cash
Outflow in Mandatory Capital Expenditures that
well as sundry investments. investors. Recur at Least Annually,” The RMA Journal, June
2001, pp. 48-53.
The three main columnar sec- It is not the intention of this
tions are also grouped by financing article to take sides in this debate,
methodology. The income over but to present both sides and rec-
expenses section effectively meas- oncile them. EBITDA was shown
ures cash-flow-based lending for to be a component of cash flow,
the period, and hopefully lenders and from there the remaining
would have calculated debt serv- components of cash flow were
ice to fit within the parameters of repositioned in a way that hope-
net adjusted EBIDA. The net fully makes the most sense for
working investment section lenders and analysts working with

34 The RMA Journal December 2002 - January 2003