Cash Flow vs. EBIT (With Similarities and Differences)
By Indeed Editorial Team
Published March 11, 2022
The Indeed Editorial Team comprises a diverse and talented team of writers, researchers and subject matter experts equipped with Indeed's data and insights to deliver useful tips to help guide your career journey.
When researching companies you might want to invest in, it's important to analyze their finances. Understanding how much capital a company generates compared to how many financial obligations it has can be a good way to determine financial sustainability. If you want to learn about some different methods you can use to analyze the financial structure of a company, reading about cash flow and EBIT can be a good place to start. In this article, we explain what cash flow is, what EBIT is and their similarities and differences.
What is cash flow?
Cash flow is the amount of unencumbered cash that a business has access to. For cash to be unencumbered, the company must be able to spend or save it with no obligation to pay back another party. For example, if a business earns $40,000 a month but spends $5,000 for necessary materials and spends another $3,000 on renting office space, then the business generates $32,000 worth of unencumbered cash each month. The business is free to use the remaining $32,000 on anything else it needs, so it has a monthly cash flow of $32,000.
Measuring the cash flow of a company is a common strategy for financial analysts who want to learn about how a company's operating budget compares to any financial obligations it may have. The cash flow of a company tells investors how much it has available for discretionary spending, which can be useful if the business wants to expand or develop into new areas. By looking at a company's flow of cash, analysts can determine whether the company maintains a healthy balance between spending and saving liquid assets.
What is EBIT?
The term EBIT stands for earnings before interest and taxes. Looking at the EBIT of a company is a common way for investors to analyze financial performance and sustainability. Because EBIT doesn't take capital structure or use of debt into account, it can be an effective way to compare similar businesses. This is because an EBIT analysis measures the constant rate of income for a business while ignoring factors like the depreciation of assets or how much debt the company has. Here's a breakdown of each component of an EBIT analysis:
When calculating EBIT, analysts look at the operating income of a company to determine its earnings. Operating income refers to the amount of money that a company generates after accounting for certain overhead costs and other operational expenses. Because operating income reflects how much money a company can spend on new expenses without taking on debt, it's a useful metric for determining the financial status of a business.
Interest refers to the development of financial assets over time. Depending on what industry the company works in, it could earn interest on a variety of different financial assets, such as stocks, bonds or loans. Interest is not a part of EBIT analyses because financial analysts want to determine how much money a company generates from its business practices and not from the increase in value from any assets that it holds. By ignoring interest, investors can see how much cash the company generates.
Although taxes can affect how much money a business has to spend on its operational expenses, EBIT calculations ignore taxes to normalize expenditures between different businesses. Because investors typically use EBIT calculations to compare similar companies, they don't factor in the amount of tax the company pays. This is because the company itself has no control over the amount.
Cash flow vs. EBIT
Cash flow and EBIT are both common methods that financial analysts use when researching companies, but there are some key differences between the two. Depending on the reason that you are looking at a company's finances, one approach might be better than the other. It can also be beneficial to use both approaches to compare your results. Here are some of the important differences between cash flow and EBIT:
Liquidity refers to the amount of cash on hand that a company has. Cash on hand is capital that is not used for any assets and is available to spend on new assets or invested. When comparing the differences between cash flow and EBIT, cash flow analysis provides a more in-depth look into the amount of liquid capital that a company can access.
When reporting on the financial structure of a company, EBIT and cash flow approaches use different strategies. EBIT gives the company more ways to inflate its value since operating expenses are included in the initial calculation when determining operational income. Some investors view cash flow accounting as the more transparent method, since this approach provides a more in-depth breakdown of the various expenses that affect revenue streams. Cash flow accounting also takes taxes and interest into consideration, while EBIT disregards these factors to provide a more comparative analysis.
Interest is the increase in the value of the financial assets that a company owns. Depending on what type of business the company engages in, it may receive interest as financial payments as its assets appreciate. Cash flow analyses look at the interest generated by a company as another form of capital, while EBIT calculations ignore interest altogether. Because EBIT is typically used to compare two companies rather than provide a detailed analysis of a single company, it disregards factors that may provide inconsistent results between multiple businesses.
Similarities between cash flow and EBIT
Although there are some important distinctions between cash flow and EBIT, some investors use these terms interchangeably. This is because they are both ways to investigate the financial health of a company by analyzing the amount of capital it generates. When investigating the finances of a company, some analysts choose to use both methods to gain even further insight into the financial dealings. Here's a list of the similarities between the two terms:
Overhead costs are recurring expenses that a business needs to pay in order to stay operational. Overhead costs include things like rent, employee wages, licensing fees and a variety of other costs. When analyzing a company's finances, EBIT calculations subtract overhead costs from the initial operating income used to perform the analyses. Cash flow analyses also subtract overhead costs from the amount of cash a company generates, as these costs are necessary to stay in business.
Depreciation is when the value of financial assets decreases. Many types of assets, like stocks and real estate holdings, can decrease in value. Cash flow and EBIT don't take depreciation of assets into account, so some analysts rely on different methods when looking at the depreciation of a company's assets.
Amortization refers to paying back loans that a company borrowed. Cash flow and EBIT both disregard amortization when analyzing the financial structure of a company, as these approaches are more concerned with how much capital a company produces. Looking at the amortization of a company's loans can still be an important part of your research, so it may be useful to combine these methods with another approach.
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