When starting and running a business, it’s easy to focus on profit as the ultimate measure of success.
But profit, EBITDA, and free cash flow all tell different stories about your business’ financial health.
Many business owners have seen a “profitable” business go under because it ran out of cash.
Others have been told their EBITDA looks great—without realising it hides critical costs.
So, what do these numbers actually mean?
What is EBITDA vs Cash Flow vs Profit and which one should you focus on?
Let’s break down the basics of business in plain English—no finance degree required!
Profit: Are You Really Making Money or Just Look Good On Paper?
Profit is what’s left after subtracting costs from revenue, but there are three key types to track:
1. Gross Profit
Formula: Sales – Direct Costs (e.g. ingredients for a bakery)
Tells you: Are you pricing your product correctly?
2. Operating Profit (EBIT)
Formula: Gross Profit – Operating Expenses (e.g. rent, salaries, utilities)
Tells you: Is your core business model actually profitable?
3. Net Profit
Formula: Operating Profit – Taxes & Loan Interest
Tells you: How much of your revenue actually stays in your pocket?
Key takeaway: Profit shows if you’re earning more than you spend, but it doesn’t tell you if you have enough cash to pay your bills on time.
EDITDA: Why It’s Loved (and Misleading)
What is EBITDA?
EBITDA = Earnings Before Interest, Taxes, Depreciation, and Amortisation
Why It Exists:
In the 1970s, a Canadian businessman used EBITDA to convince lenders he could afford more financing. Today, it’s widely used to compare businesses—without factoring in loans, taxes, or equipment costs.
When EBITDA Can Be Useful:
✅ Helps compare businesses in different tax environments
✅ Shows earnings potential before financial obligations
The Catch:
❌ Ignores essential costs (like replacing equipment)
❌ Can make struggling businesses look healthier than they are
Real-World Example: The Laundromat Trap
Two laundromats have identical EBITDA.
- One replaces washing machines every 2 years.
- The other replaces them every 10 years.
On paper, both look equally profitable—but the first has far higher long-term costs.
🚨Beware of “Adjusted EBITDA”—where even more costs are excluded, potentially painting an overly rosy picture.
Words of Wisdom: “Depreciation is a real expense. You just pay for it upfront.”
Warren Buffett, the famous investor and philanthropist
Free Cash Flow: The #1 Reason Businesses Fail
What is Free Cash Flow (FCF)?
Formula: Cash from operations – Taxes – Interest – Capital Expenditure (e.g., new equipment)
Tells you: How much cash you actually have left to grow, pay debts, or survive tough times.
Why It’s Critical:
✅ Accounts for timing differences (e.g., customers paying late)
✅ Includes unavoidable costs (e.g., replacing essential equipment)
Real-World Example: The Clothing Store Struggle
A clothing store shows a profit but has negative cash flow because it’s spending heavily on inventory that hasn’t sold yet.
Key insight: Profit ≠ Cash. Many “profitable” businesses fail because they run out of cash.
Profit vs. EBITDA vs. Free Cash Flow: What to Watch For
| METRIC | BEST FOR …. | WATCH OUT FOR … |
| Profit | Measuring overall success | Doesn’t show cash availability |
| EBITDA | Comparing businesses | Hides equipment replacement costs |
| Free Cash Flow | Checking if you can pay bills | Can fluctuate month-to-month |
The Bottom Line for Business Owners …
- Profit answers: Are we making money?
- EBITDA answers: How much could we earn in an ideal world?
- Free Cash Flow answers: Can we keep the lights on?
📌 Use all three together. Track profit monthly, but check cash flow weekly.
And next time someone praises your EBITDA, ask them:
“But what’s the real cost of keeping this business running?”
So in summary it is key to remember:
✅ Profit is your report card.
✅ Free Cash Flow is your oxygen tank
❌ AND … never confuse the two!
Before You Go …
Whether you are an established business or a start up one of the key basic elements of financial control is predicting what’s going to happen in the future.
This requires putting together a solid financial forecast. Download our simple FREE cashflow forecast template to do just that.
