What Are the Differences Between EBITDA and Working Capital?
Earnings are the profit a corporation reports, which takes into account taxes and other expenses the corporation is obligated to pay. EBITDA means earnings before interest, taxes, depreciation and amortization. It is an accounting tool that's used to measure a company's cash flow by omitting some expenses to show the money made from business operations. Working capital is the amount of cash a business has for operating expenses. Put simply, EBITDA is the cash a company brings in, while working capital is the cash a company keeps on hand.
EBITDA is used to give some insight into your company's basic ability to be profitable and pay off debts, according to Inc. EBITDA is the money a company brought in without taking out many of the mandatory expenses that will have to be paid. Because of this, EBITDA does not conform with the generally accepted accounting principals, which means it can be adjusted in many ways to help come up with a realistic measure of a company's finances.
Working capital is calculated by subtracting a business' current liabilities from its current assets. The Small Business Administration defines current liabilities as any debt the business will have to pay within one year, which can include payroll, accounts payable, owed taxes and debt repayment. Current assets include cash, inventory or investments. Having a positive working capital is crucial for a business to maintain its business operations. Working capital gives a business the flexibility to expand their operations or manage a challenging economy.
Depreciation and amortization are ways that companies spread large costs over a period of time. For example, a company that pays $600 for a new piece of equipment that is expected to last three years could use depreciation rules to spread the cost into $200 yearly payments, for accounting purposes. Without depreciation, the $600 equipment expense could result in wild swings in the company's balance sheet as the earnings from the first year would be lower to reflect the machine's cost while earnings in the following years would be higher to reflect the profits earned from its use. Amortization is similar to depreciation except that it is generally used for finance charges, such as interest rates.
EBITDA relates to working capital in that it can help give a picture of how much cash a company is able to accumulate. However, EBITDA does not take a company's working capital into account. Because of the subtractions from earnings, EBITDA can make a company more profitable than it is. Operating profit is a similar accounting measurement used to measure cash flow that takes into account depreciation and amortization, which some analysts believe need to be reflected in earnings data, according to Motley Fool.