Free Cash Flow

Definition

Where EBITDA is a profit measure, free cash flow measures genuinely available cash. The difference is capex (maintenance and growth investment) and the change in working capital: two items EBITDA ignores but a new owner certainly feels.

In a DCF valuation you project free cash flow over several years and discount it at the WACC. For asset-heavy sectors (manufacturing, transport) FCF is often well below EBITDA: which is exactly why valuation experts warn against relying blindly on EBITDA multiples there.

Worked example

A manufacturer has €1.0m EBITDA, pays €180k tax, invests €350k in machinery (capex) and sees working capital rise €70k. Free cash flow = 1,000 − 180 − 350 − 70 = €400k: less than half the EBITDA.

When it matters

For capital-intensive businesses FCF is fairer than EBITDA. A buyer who acquires a manufacturer on an EBITDA multiple without looking at capex is paying for cash that will never arrive.

Frequently asked

What is the difference between free cash flow and EBITDA?

EBITDA ignores capex and working capital; free cash flow subtracts both. For asset-heavy businesses FCF can be half of EBITDA or less; for light service businesses they sit closer together.

Which cash flow do I use in a DCF?

Usually unlevered free cash flow (free cash flow before financing), discounted at the WACC. This values the operation independently of the financing structure.

Why does working capital matter for FCF?

Growth consumes cash: rising inventory and receivables tie up money that is not freely available. A growing business can be profitable on paper yet show little free cash flow.