Cash EBITDA vs. EBITDA: A Comprehensive Guide for Business Owners
Published on December 9, 2024
Sam Parr’s tweetsparked a lively debate about whether EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization) is a flawed metric for business owners, particularly in industries like SaaS. He proposed an alternative—Cash EBITDA—as a better reflection of a business’s financial health. But is it? Why don’t more businesses adopt it? And what do accountants, entrepreneurs, and investors think about this idea?
In this post, we’ll explore:
[img width=573.003px]//5ac7a397a9cdce6ee24685b64d3ecb28.cdn.bubble.io/f1734124218444x764338244162498400/richtext_content.png[/img]
EBITDAmeasures a company’s profitability by excluding non-operational expenses like interest, taxes, depreciation, and amortization. It’s a standardized metric often used to:
However, critics like Charlie Munger have famously referred to EBITDA as “bullsh*t earnings.”
Why?
Because it ignores critical factors like capital expenditures (CapEx) and cash flow, which can paint a misleading picture of financial health. A company might have strong EBITDA but still struggle with cash flow issues that threaten its survival.
Sam Parr’s proposedCash EBITDAmodifies traditional EBITDA by:
For example, a SaaS company charging $1M annually upfront would report $83K in monthly revenue under traditional EBITDA. In Cash EBITDA, the entire $1M collected upfront would count immediately, minus costs for that month.
Here's how the blog post draft would look like, starting with the introduction and structuring the content to address both Sam Parr's tweet and the insightful comments.
As several Twitter commenters pointed out, cash flow is critical for a company’s survival. Even profitable businesses can fail if they lack liquidity to cover operational costs. Metrics likeCash EBITDAorOperating Cash Flowfocus on actual cash movements, helping business owners:
Cash EBITDA is particularly appealing in industries like SaaS, where upfront payments for long-term services create deferred revenue. By focusing on cash collected, it provides a clearer picture of a SaaS company’s liquidity and operational flexibility.
Sam’s intuition resonates with entrepreneurs who prioritize metrics like “cash in the bank” or “runway.” These measures offer real-time insight into a business’s ability to sustain operations, especially during uncertain times.
EBITDA is widely understood and used across industries. Metrics like Cash EBITDA lack the same standardization, making them harder to compare or communicate to external stakeholders like investors or lenders.
Cash EBITDA aligns more closely with cash-based accounting, which is typically reserved for small businesses. Most larger companies use accrual accounting because it matches revenues and expenses within the same period, providing a more consistent view of profitability.
As several comments noted, focusing solely on cash metrics like Cash EBITDA could lead to bad business decisions, such as:
Metrics likeOperating Cash Flow,Free Cash Flow (FCF), orDistributable Profitalready address cash concerns while maintaining accounting rigor. Many accountants and financial experts argue these are more practical than redefining EBITDA.
[highlight=oklch(0.99 0.004 106.471)]Several commenters on Sam's post suggested alternative metrics that might be more appropriate:
There’s no one-size-fits-all metric for every business. The right approach depends on your industry, stage, and priorities.
Here are some suggestions based on the discussion:
Relying on a single metric like EBITDA or Cash EBITDA is risky. Instead, consider:
If you introduce a custom metric like Cash EBITDA, ensure all stakeholders understand its definition, calculation, and purpose. This prevents confusion and builds trust with investors, lenders, and your team.
Sam Parr’s idea for Cash EBITDA sparked a valuable conversation about the limitations of traditional metrics like EBITDA. While Cash EBITDA might not replace standard measures, it highlights the importance of tailoring metrics to your business’s unique needs.
As many commenters pointed out, the key takeaway is this:Cash flow matters.Whether you use Cash EBITDA, Operating Cash Flow, or another metric, the goal is to understand and manage the financial realities of your business effectively.
Looking for an accountant or Fractional CFO to help you navigate these metrics? VisitSam's Listto find financial professionals who can guide your business to success!
In this post, we’ll explore:
- The differences between EBITDA, Cash EBITDA, and other financial metrics.
- Why EBITDA remains a popular metric despite its limitations.
- The case for alternative cash-based metrics.
- Practical advice on financial metrics for business decision-making.
[img width=573.003px]//5ac7a397a9cdce6ee24685b64d3ecb28.cdn.bubble.io/f1734124218444x764338244162498400/richtext_content.png[/img]
Understanding Cash EBITDA
What is EBITDA?
EBITDAmeasures a company’s profitability by excluding non-operational expenses like interest, taxes, depreciation, and amortization. It’s a standardized metric often used to:
- Compare operational performance across industries.
- Assess a company’s earning potential without the noise of financing or accounting decisions.
- Evaluate a business for acquisition or investment purposes.
However, critics like Charlie Munger have famously referred to EBITDA as “bullsh*t earnings.”
Why?
Because it ignores critical factors like capital expenditures (CapEx) and cash flow, which can paint a misleading picture of financial health. A company might have strong EBITDA but still struggle with cash flow issues that threaten its survival.
What is Cash EBITDA?
Sam Parr’s proposedCash EBITDAmodifies traditional EBITDA by:
- Subtracting all non-cash expenses.
- Recognizing revenue when cash is collected(rather than spreading it over the contract term, as accrual accounting requires).
For example, a SaaS company charging $1M annually upfront would report $83K in monthly revenue under traditional EBITDA. In Cash EBITDA, the entire $1M collected upfront would count immediately, minus costs for that month.
Here's how the blog post draft would look like, starting with the introduction and structuring the content to address both Sam Parr's tweet and the insightful comments.
The Argument for Cash EBITDA
1. Cash is King
As several Twitter commenters pointed out, cash flow is critical for a company’s survival. Even profitable businesses can fail if they lack liquidity to cover operational costs. Metrics likeCash EBITDAorOperating Cash Flowfocus on actual cash movements, helping business owners:
- Track liquidity.
- Make better decisions about spending, investments, or distributions.
- Avoid overextending based on “paper profits.”
2. SaaS and Deferred Revenue
Cash EBITDA is particularly appealing in industries like SaaS, where upfront payments for long-term services create deferred revenue. By focusing on cash collected, it provides a clearer picture of a SaaS company’s liquidity and operational flexibility.
3. Aligning Metrics with Reality
Sam’s intuition resonates with entrepreneurs who prioritize metrics like “cash in the bank” or “runway.” These measures offer real-time insight into a business’s ability to sustain operations, especially during uncertain times.
Why Isn’t Cash EBITDA More Common?
1. Lack of Standardization
EBITDA is widely understood and used across industries. Metrics like Cash EBITDA lack the same standardization, making them harder to compare or communicate to external stakeholders like investors or lenders.
2. Accrual vs. Cash Accounting
Cash EBITDA aligns more closely with cash-based accounting, which is typically reserved for small businesses. Most larger companies use accrual accounting because it matches revenues and expenses within the same period, providing a more consistent view of profitability.
3. Misleading Performance Indicators
As several comments noted, focusing solely on cash metrics like Cash EBITDA could lead to bad business decisions, such as:
- Underestimating long-term obligations (e.g., deferred revenue).
- Ignoring the value of accrued earnings or assets.
- Mismanaging investments that rely on capital expenditures.
4. Alternatives Already Exist
Metrics likeOperating Cash Flow,Free Cash Flow (FCF), orDistributable Profitalready address cash concerns while maintaining accounting rigor. Many accountants and financial experts argue these are more practical than redefining EBITDA.
[highlight=oklch(0.99 0.004 106.471)]Several commenters on Sam's post suggested alternative metrics that might be more appropriate:
- Operating Cash Flow: As @stockgeekTV notes, "You're essentially getting to Cash Flow from Operations, which many businesses do use."
- Free Cash Flow: @MontecassinoLP suggests, "Sir, with all due respect, you've re-discovered Free Cash Flow ("FCF")."
- Cash Conversion Cycle: This metric can be useful for understanding a company's working capital efficiency.
- Adjusted EBITDA: Many companies use Adjusted EBITDA, which includes various add-backs for non-recurring or extraordinary items.
Choosing the Right Metrics
There’s no one-size-fits-all metric for every business. The right approach depends on your industry, stage, and priorities.
Here are some suggestions based on the discussion:
1. Understand Your Business Model
- SaaS companies with deferred revenue may benefit from monitoring Cash EBITDA alongside accrual-based metrics.
- Asset-heavy businesses or those with significant CapEx should prioritize Free Cash Flow.
2. Use Multiple Metrics
Relying on a single metric like EBITDA or Cash EBITDA is risky. Instead, consider:
- EBITDAfor standardized comparisons.
- Cash Flow from Operationsfor liquidity insights.
- Net Incomefor profitability.
- Runway and Burn Ratefor startups managing cash reserves.
3. Communicate Clearly
If you introduce a custom metric like Cash EBITDA, ensure all stakeholders understand its definition, calculation, and purpose. This prevents confusion and builds trust with investors, lenders, and your team.
The Verdict: Is Cash EBITDA the Future?
Sam Parr’s idea for Cash EBITDA sparked a valuable conversation about the limitations of traditional metrics like EBITDA. While Cash EBITDA might not replace standard measures, it highlights the importance of tailoring metrics to your business’s unique needs.
As many commenters pointed out, the key takeaway is this:Cash flow matters.Whether you use Cash EBITDA, Operating Cash Flow, or another metric, the goal is to understand and manage the financial realities of your business effectively.
Looking for an accountant or Fractional CFO to help you navigate these metrics? VisitSam's Listto find financial professionals who can guide your business to success!
Comments & Questions
Sign up or log in to comment
© 2024 Copyright Sam's List
