A company can report record profits on Monday and file for bankruptcy on Friday. This paradox occurs when leaders confuse operational potential (EBITDA) with the actual liquidity required to survive and grow (Cash Flow).
Simple Definition
These three metrics measure performance through different lenses of "truth."
EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization) is a proxy for raw operational profitability. It removes the effects of financing decisions, tax environments, and accounting decisions regarding asset aging.
Operating Cash Flow (OCF) adjusts net income for non-cash items and changes in working capital. It tells you if the core business operations are generating cash or burning it.
Free Cash Flow (FCF) is the cash remaining after the company pays to maintain or expand its asset base. It represents the actual disposable cash available to shareholders and lenders.
Simple Example
Imagine a logistics company that just landed a massive contract.
The EBITDA View: The company invoices $1 million in services with $800,000 in operating costs. EBITDA shows a healthy $200,000 profit. The business looks robust.
The OCF View: The client has 90-day payment terms, meaning the $1 million hasn't hit the bank yet. However, the company paid its drivers and fuel costs immediately. OCF shows a negative $800,000. The business is bleeding liquidity despite being "profitable."
The FCF View: To service the contract, the company bought two new trucks for $100,000 cash. FCF starts with the negative OCF and subtracts this capital expenditure (CapEx). FCF shows a negative $900,000.
EBITDA shows the potential; OCF shows the liquidity crunch; FCF shows the total cost of growth.
Comparative Analysis
Use this framework to determine which metric to prioritize based on your current objective.
Metric | Primary Question Answered | Best Use Case | Blind Spot |
EBITDA | Is the core business model sound? | Comparing companies in the same industry with different debt or tax structures. | Ignores capital intensity and working capital swings. |
OCF | Can we pay the bills? | Managing liquidity, payroll, and short-term survival. | Ignores the cost of replacing aging equipment. |
FCF | Is this creating value for owners? | Valuation, determining dividend capacity, and paying down debt. | Can be volatile based on timing of large investments. |
Why It Matters
Relying solely on EBITDA is dangerous for capital-intensive or high-growth businesses. It frequently masks cash flow problems caused by piling up inventory or slow-paying customers.
Conversely, managing strictly for FCF in a startup phase can stifle growth, as it discourages necessary heavy investment.
Effective leaders triangulate these three. Use EBITDA to benchmark your margins against competitors. Monitor OCF to ensure you don't run out of runway. Optimize FCF to maximize the long-term value of the enterprise.
Quick Summary
EBITDA measures potential profitability, Operating Cash Flow measures liquidity, and Free Cash Flow measures the actual distributable wealth generated by the business.