How do you calculate EBITDA-to-cash conversion?
A core Private Equity interview question — asked in analyst and associate interviews across IB, PE, and the Big 4.
THE SHORT ANSWER
(EBITDA - Capex - Change in NWC - Cash Taxes) / EBITDA. A good business converts 70-85%. Below 60% is a warning sign — EBITDA is 'paper profit' not backed by cash. Common reasons for low conversion: high capex, growing NWC (rapid growth consuming cash), aggressive revenue recognition, or large provision movements.
WHAT INTERVIEWERS LISTEN FOR
- ✓Formula: (EBITDA - Capex - Change in NWC - Cash Taxes) / EBITDA
- ✓Healthy range: 70-85%
- ✓Below 60% is warning sign
- ✓EBITDA is paper profit
- ✓Reasons for low conversion
COMMON MISTAKES
- ✗Using net income instead of EBITDA
- ✗Ignoring cash taxes
- ✗Confusing with free cash flow margin
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