EBITDA sets the multiple, the leverage cap, and most of the headline terms. Cash flow decides whether the company survives the structure those terms create. They are different numbers, they diverge most sharply during growth, and a business can be excellent on one and failing on the other.
What is the difference between EBITDA and cash flow?
EBITDA is earnings before interest, taxes, depreciation, and amortisation. It is an approximation of operating profitability that deliberately ignores capital structure and non-cash charges. Cash flow is what actually moves through the bank account after working capital, capital expenditure, interest, taxes, and debt principal.
Five items sit between them, and all five are real cash.
The five items between EBITDA and cash
- Working capital investment. Growth consumes cash into receivables and inventory before customers pay.
- Capital expenditure. EBITDA adds back depreciation, but the machine still has to be replaced.
- Cash interest. Excluded from EBITDA by construction, paid monthly in fact.
- Cash taxes. Same.
- Debt principal. Not an expense at all, and often the largest single cash outflow in the year.
A worked example
A company with $2,000,000 of EBITDA, growing revenue 25%:
| Line | Amount |
|---|---|
| EBITDA | $2,000,000 |
| Increase in receivables | ($600,000) |
| Increase in inventory | ($400,000) |
| Increase in payables | $250,000 |
| Capital expenditure | ($300,000) |
| Cash interest | ($400,000) |
| Cash taxes | ($250,000) |
| Debt principal repayment | ($500,000) |
| Cash flow | ($200,000) |
Two million of EBITDA, and the business consumed $200,000 of cash. Nothing here is a failure. The company is profitable, growing, and paying its debt on schedule. It is simply funding its own growth out of a cash flow that is $2.2M smaller than the number everyone is quoting.
Why does growth make this worse?
Because working capital scales with revenue and arrives before the cash does. Every additional dollar of sales is a dollar of receivable financed for the length of your collection cycle, plus inventory bought ahead of it.
That is why fast-growing, profitable companies run out of money, and why the constraint is structural rather than managerial. The staffing version of this, where payroll is weekly and collection is monthly, is in staffing agency financing, and the seasonal version is in seasonality.
Which number does a lender use?
Both, for different jobs.
EBITDA sizes the facility. Leverage multiples, purchase price multiples, and enterprise value are all expressed against it, because it allows comparison across companies with different capital structures.
Cash flow tests whether the structure holds. The coverage ratio is a cash test, and it is the constraint that binds first on most middle-market deals, as shown in debt capacity and computed in DSCR, FCCR, and the coverage ratios that decide your file.
A file that looks comfortable on leverage and tight on coverage will be structured around the coverage.
What is free cash flow, then?
There is no single definition, which is a genuine problem in practice rather than an academic quibble. Different parties mean different things: operating cash flow less capital expenditure, cash flow after debt service, or cash flow available to equity. Two people can compute free cash flow from the same statements and differ by a million dollars.
When it appears in a covenant, in a cash sweep, or in a term sheet, read the definition in the document rather than assuming. Definitions matter more than levels, which is the argument made throughout loan covenants explained.
Does the gap ever close?
Yes, and predictably. A mature business growing slowly has small working capital swings, so EBITDA and cash flow converge and the shorthand becomes reasonable. A business growing 25% a year, or one that is capital intensive, or one carrying heavy amortisation, will diverge every year.
Know which kind you are before accepting a structure priced on the multiple.
What should an owner actually track?
A monthly cash flow forecast rolling twelve months forward, built from the five items above, tested against the covenant. That single exhibit answers the questions that arrive from a lender in a difficult quarter, and it is the one that shows a problem early enough to be negotiable rather than announced.
The short version
EBITDA is a comparison tool and cash flow is a survival test. Five real cash items sit between them, they diverge most in the years a company grows fastest, and it is entirely possible to post record EBITDA and end the year with less money than you started with.