EBITDA vs Cash Flow for Lending: Why CFADS Wins for Debt Decisions

Key Points

• EBITDA is a flawed metric for lending decisions because it ignores taxes, interest, capital expenditures, and working capital shifts.
• CFADS (Cash Flow Available for Debt Service) provides a more accurate measure of repayment capacity by reflecting real cash movement.
• Businesses that focus on Cash Conversion Cycle (CCC) improvements free up capital and reduce reliance on external debt.
• Capital Source (CSG) uses CFADS and CCC data to structure stress-free financing solutions for growing businesses.

Executive Summary

EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization) has long been trusted by boards and investors as a key performance metric. Yet, for lending and operational decisions, it often paints a misleading picture. EBITDA can inflate a company’s perceived financial health by ignoring vital cash outflows. The real measure of lending strength is Cash Flow Available for Debt Service (CFADS), which captures the actual movement of money.

This article explains why EBITDA vs Cash Flow for Lending is not just a technical comparison but a financial strategy decision that defines whether your business is funding growth or bleeding liquidity.

I. The Four Fatal Flaws of EBITDA

EBITDA is an accounting proxy that masks cash flow realities. Its flaws include:

1. Ignoring Taxes: Taxes are a real cash expense, not an accounting adjustment. Excluding them inflates profitability.
2. Ignoring Interest: Companies borrow money to operate. Removing debt costs from performance metrics misrepresents financial health.
3. Ignoring Capital Expenditures (CapEx): A company that barely covers depreciation through EBIT is not generating sustainable cash flow.
4. Ignoring Working Capital Shifts: The most dangerous oversight—a company can book sales and increase EBITDA while cash remains uncollected.

Example: A distributor shows $1.2 million in EBITDA but loses $200,000 in operating cash due to slow-paying customers. This creates a dangerous illusion for lenders relying on EBITDA as a sign of strength.

II. The Inventory Manipulation Game

A common way to inflate EBITDA is through the Inventory Valuation Trick. By failing to write down obsolete or slow-moving inventory, companies reduce the Cost of Goods Sold (COGS), boosting EBITDA artificially. Yet, this locks up cash in unsellable stock and distorts true performance.

III. CFADS: The True Measure of Debt Capacity

CFADS (Cash Flow Available for Debt Service) measures the cash actually available to meet debt obligations. It corrects for the blind spots of EBITDA and aligns with lender priorities.

Formula:
CFADS = (Cash Flow from Operations – Cash Taxes) – CapEx

This formula exposes whether a company is truly generating cash or merely reporting profits.

IV. The Cash Conversion Connection (CCC)

Improving the Cash Conversion Cycle (CCC) accelerates Cash Velocity and strengthens CFADS. Each day shaved from CCC frees working capital for growth.

• DIO (Days Inventory Outstanding): Reduce by improving turnover.
• DSO (Days Sales Outstanding): Shorten collection time.
• DPO (Days Payables Outstanding): Extend where strategically possible.

A company that improves its CCC by even 30 days can add weeks of liquidity to its balance sheet without external financing.

V. How Capital Source Group Uses CFADS

At Capital Source Group, we assess CFADS and CCC together to craft lending strategies that align debt with cash flow reality. Our financing avoids creating cash stress points and instead supports long-term liquidity stability.

Frequently Asked Questions (FAQ)

Q1: Is CFADS better than EBITDA for lending decisions?

Yes. CFADS measures actual cash available for debt repayment. EBITDA only adjusts accounting figures and ignores cash timing, making it unreliable for lending analysis.

Q2: How do DSO and DIO affect CFADS?

Increases in DSO (slow customer payments) or DIO (excess inventory) reduce cash flow, lowering CFADS. Monitoring these metrics ensures accurate lending capacity evaluations.

Q3: What is the difference between cash flow lending and asset-based lending?

Cash flow lending relies on cash generation capacity (CFADS) for credit analysis, while asset-based lending (ABL) uses receivables or inventory as collateral. Both can complement each other in a well-structured financing stack.

Q4: How can improving the Cash Conversion Cycle improve borrowing potential?

Shortening the CCC directly increases available cash, improves CFADS, and reduces dependency on high-interest short-term debt.