EBITDA versus operating profit versus free cash flow
Three measures, three different questions. Why two companies with the same EBITDA can produce very different cash, and how lease accounting lifts EBITDA.
Key takeaways
- EBITDA asks what the operations earn before the cost of the assets they use.
- Common mistakes: Treating EBITDA as cash.
- IFRS Foundation: IFRS 16 Leases (standard summary): https://www.ifrs.org/issued-standards/list-of-standards/ifrs-16-leases/.
Key idea
EBITDA asks what the operations earn before the cost of the assets they use. Operating profit (EBIT) asks what they earn after wearing those assets out. Free cash flow asks how much cash is really left for lenders and owners after tax, new investment and working capital.
| Measure | How to get it | What it is good for | What it hides |
|---|---|---|---|
| EBITDA | Operating profit plus depreciation and amortization | Comparing operating performance across companies with different assets, debt and tax | The cost of replacing assets (capex), working capital, tax and interest |
| EBIT (operating profit) | EBITDA minus depreciation and amortization | Profit after the wear of assets; closer to long-run earning power | Timing of cash, working capital, and whether capex is higher than depreciation |
| Free cash flow (unlevered) | EBIT after tax, plus depreciation and amortization, minus capex, minus the increase in working capital | Cash available to lenders and owners; the basis of a DCF valuation | It is lumpy: one large investment year can make it negative |
So-what
The further down this table, the closer to cash, and the harder to flatter.
EBIT after tax has a name: net operating profit after tax, or NOPAT. It is the profit the operations would earn if the company had no debt. "Unlevered" free cash flow means cash before any interest or debt payments, so it belongs to lenders and owners together. Companies also publish their own versions of free cash flow, often after interest or lease payments, so always read the definition.
Worked case
Same EBITDA, very different cash
The prompt
Two fictional companies each report EBITDA of USD 100 million. A mobile operator in Southeast Asia has depreciation of 45 and spends 50 a year on its network. A software firm has depreciation of 5, spends 5 a year on equipment, and its working capital falls by 5 because customers pay a year in advance. Tax is 20 percent for both (illustrative). Which business produces more cash?
The structure
- Free cash flow = EBIT x (1 minus tax) + depreciation minus capex minus the increase in working capital (this comes from the question: cash, not profit)
- EBIT and NOPAT for each company
- Add back depreciation, subtract capex and working capital
- Free cash flow as a share of EBITDA
Working it through
1. Operator EBIT
EBITDA 100 minus depreciation 45.
Operator EBIT (USD millions):100 - 45 = 552. Operator NOPAT
Keep 80 percent after tax.
Operator NOPAT (USD millions):55 × 0.8 = 443. Operator free cash flow
NOPAT 44, plus depreciation 45, minus network capex 50.
Operator free cash flow (USD millions):44 + 45 - 50 = 394. Software EBIT and NOPAT
EBITDA 100 minus depreciation 5 is 95; keep 80 percent.
Software NOPAT (USD millions):(100 - 5) × 0.8 = 765. Software free cash flow
NOPAT 76, plus depreciation 5, minus capex 5, plus 5 because working capital fell.
Software free cash flow (USD millions):76 + 5 - 5 + 5 = 816. Compare
Free cash flow as a share of EBITDA.
Software free cash flow divided by operator free cash flow:81 ÷ 39 = 2.08
The recommendation
The software firm produces about twice the cash: USD 81 million of free cash flow against 39 million, from the same USD 100 million of EBITDA. The reason is that the operator must spend 50 a year to keep its network running, while the software firm needs little equipment and its customers pay in advance. This means that a buyer paying the same multiple of EBITDA for both would be overpaying for the operator. The risk on the software side is that the advance payments reverse if growth stops. As a next step, compare capex with depreciation over five years for both.
Leases can make EBITDA look bigger
Under IFRS 16, the lease rule used by companies reporting under International Financial Reporting Standards since 2019, a company that rents shops, offices or aircraft records a right-of-use asset and a lease liability on its balance sheet (IFRS Foundation, checked 2026-10-01). Most rent then leaves operating costs and comes back as depreciation and interest, which sit below EBITDA. The rent is still paid every month, but EBITDA no longer counts it. Inditex shows the gap clearly: in the year to 31 January 2026, rental expenses inside its operating costs were EUR 1,085 million, while its cash flow statement shows EUR 1,834 million of lease payments, inside financing cash flow. That is why Inditex itself also reports "lease adjusted" cash measures that take those payments off.
Inditex reported EBITDA of EUR 11,267 million on sales of EUR 39,864 million in FY2025, and lease payments of EUR 1,834 million. As a rough check, take all the lease payments off EBITDA. What share of sales is left, in percent, to one decimal place?
A company in India has EBITDA of INR 80 crore and depreciation of INR 20 crore. Tax is 25 percent. It spends INR 30 crore on capex and working capital rises by INR 5 crore. What is its unlevered free cash flow, in INR crore?
Treating EBITDA as cash. Accepting "adjusted EBITDA" without reading what was adjusted: some "one-off" costs come back every year. Comparing EBITDA margins between a company that leases its shops and one that owns them, or between IFRS and other accounting rules. Judging free cash flow on one year: a heavy investment year can make a strong business look weak.
Capex is much higher than depreciation, year after year. What does that suggest?
Why does IFRS 16 raise EBITDA for a retailer that rents its stores?
Facts checked against sources on 2026-10-01. Sources, company filings and standard setters first.
- IFRS Foundation: IFRS 16 Leases (standard summary): https://www.ifrs.org/issued-standards/list-of-standards/ifrs-16-leases/
- Inditex: FY2025 Results (1 February 2025 to 31 January 2026), results release with consolidated income statement, balance sheet and cash flow statement: https://www.inditex.com/itxcomweb/api/media/1da2c9d1-dbca-49fb-9563-982a8a27fae6/INDITEXFullYear2025.pdf
Sources for this lesson (3)
- Recognized public explanations of case-interview concepts and terms
- IFRS Foundation: IFRS 16 Leases (standard summary)
- Inditex: FY2025 Results (1 February 2025 to 31 January 2026), results release with consolidated income statement, balance sheet and cash flow statement
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