Free cash flow is operating cash flow after capital expenditures, the cash the business actually generates that is available for debt repayment, distributions, or reinvestment once it has funded its own maintenance and growth.
EBITDA is an operating performance metric. Free cash flow is closer to economic reality. A business with strong EBITDA that requires heavy ongoing capital expenditure to maintain its operations converts very little of that EBITDA into usable cash. The gap between reported EBITDA and free cash flow is one of the most important things to understand about the actual financial health of a capital-intensive business.
Buyers and lenders focus on free cash flow because it is what funds debt repayment and owner distributions, not EBITDA. A business valued at a multiple of EBITDA that converts only 40 percent of EBITDA to free cash flow is worth considerably less in economic terms than one that converts 80 percent. For business owners, tracking the conversion rate between EBITDA and free cash flow is a discipline that reveals how much of reported earnings is real and how much is consumed by the operations that generate them.
See also: EBITDA · Capital Planning · Cash Flow ForecastThe gap between EBITDA and free cash flow is one of the most consequential numbers a business produces. See how Wefinx approaches Virtual CFO services.