EBITDA to Free Cash Flow Bridge: Step-by-Step Conversion

Key takeaways

FCF = EBITDA - Interest - Taxes +/- Working Capital Changes - Capex. The bridge has five steps and each one is testable.
You cannot calculate taxes by multiplying EBITDA by the tax rate. You must first deduct D&A and interest to get pre-tax income, then apply the tax rate.
The bridge produces levered FCF (cash to equity). For unlevered FCF, exclude interest and use taxes on EBIT instead.
Under IFRS 16, lease payments are split between interest and principal. Both must be deducted to get a true FCF figure.

The Bridge: Five Steps From EBITDA to FCF

FCF = EBITDA - Net Interest Expense - Cash Taxes +/- Non-Cash Adjustments +/- Working Capital Changes - Capex

Step by step:

Start with EBITDA. This is operating profit before depreciation, amortisation, interest, and tax. It approximates operating cash generation but significantly overstates it because it ignores several real cash costs.

Subtract net interest expense. Interest is a real cash outflow to debt holders. Net interest = interest paid minus interest earned on cash balances. This step converts EBITDA into a pre-tax, post-interest measure.

Subtract cash taxes. This is where candidates make errors. You cannot multiply EBITDA by the tax rate. Taxes are levied on pre-tax income, which is EBITDA minus D&A minus interest. The correct calculation: (EBITDA - D&A - Interest) × tax rate. Alternatively, use the cash tax figure from the cash flow statement, adjusting for deferred tax movements.

Adjust for working capital changes. An increase in receivables uses cash (sold but not collected). An increase in payables provides cash (bought but not paid). An increase in inventory uses cash (bought but not sold). These adjustments convert accrual-basis earnings to actual cash.

Subtract capex. Capital expenditure is the cash spent maintaining and growing the asset base. EBITDA adds back D&A (the non-cash accounting charge), but capex is the actual cash outflow for those assets.

The Tax Trap: Why EBITDA × (1 - Tax Rate) Is Wrong

This is the single most common error in EBITDA-to-FCF conversions and it comes up regularly in interviews.

Approach	Calculation	Result
Wrong: tax on EBITDA	£100M EBITDA × 25% = £25M tax	Overstates tax by ignoring deductible expenses
Right: tax on pre-tax income	Pre-tax income = £100M - £15M D&A - £10M interest = £75M. Tax = £75M × 25% = £18.75M	Correct: D&A and interest are tax-deductible

The difference (£6.25M in this example) is the combined tax shield from depreciation and interest. A candidate who calculates taxes on EBITDA directly will understate FCF by the entire tax shield amount.

The interview tell If an interviewer asks "walk me through EBITDA to free cash flow" and the candidate says "subtract taxes at 25%," the immediate follow-up will be "taxes on what?" The correct answer is "on pre-tax income, which is EBITDA minus D&A minus interest." Getting this right signals that the candidate understands the tax shield and the distinction between accounting metrics and cash.

Levered vs Unlevered: Two Versions of the Bridge

Step	Levered FCF (FCFE)	Unlevered FCF (FCFF)
Start	EBITDA	EBITDA
Interest	Subtract net interest	Do not subtract (captured in WACC)
Taxes	On pre-tax income (EBITDA - D&A - Interest)	On EBIT (EBITDA - D&A), ignoring interest deduction
D&A	Already excluded from EBITDA (no action)	Already excluded from EBITDA (no action)
Working capital	Adjust	Adjust
Capex	Subtract	Subtract
Debt flows	Add issuance, subtract repayment	Exclude
Result	Cash to equity holders	Cash to all investors
Discount rate	Cost of equity	WACC

The unlevered version is used in DCF valuations (produces enterprise value). The levered version is used in LBO models and equity analysis (produces equity value). For a deeper treatment of unlevered FCF specifically, see Unlevered Free Cash Flow: The Formula, What to Include, and the SBC Debate.

The Lease Accounting Wrinkle

Lease accounting standards (IFRS 16 and ASC 842) changed how leases flow through the financial statements, and this directly affects the EBITDA-to-FCF bridge.

Under IFRS 16: All leases are capitalised. The lease payment is split into an interest component (in interest expense) and a principal repayment component (in financing cash flows). EBITDA no longer includes the lease expense at all, which means EBITDA is higher, but you must separately deduct both the lease interest and the lease principal to get true FCF.

Under US GAAP (ASC 842): Operating leases are still expensed through EBITDA (the operating lease expense reduces operating income). Only finance leases are split into interest and principal. So for US GAAP companies with mostly operating leases, EBITDA already captures the lease cost.

Practical rule When comparing companies across IFRS and US GAAP, or when a company has significant lease obligations, always check whether the lease expense is inside or outside EBITDA. If it is outside (IFRS 16), deduct the full lease payment (interest + principal) from the bridge. Failing to do this overstates FCF for IFRS reporters relative to GAAP reporters.

Worked Example

Item	Amount (£M)
EBITDA	100.0
D&A	(15.0)
Net interest expense	(10.0)
Pre-tax income	75.0
Cash taxes at 25%	(18.8)
After-tax income	56.3
Add back D&A (non-cash)	15.0
Working capital increase	(5.0)
Capex	(20.0)
Levered Free Cash Flow	46.3

FCF conversion: £46.3M / £100M EBITDA = 46.3%. This means 46 pence of every pound of EBITDA converts to actual cash. For context, asset-light businesses (SaaS, professional services) typically convert at 50-70%. Capital-intensive businesses (manufacturing, telecoms) convert at 20-40%.

Interview Questions

"Walk me through EBITDA to free cash flow."

Start with EBITDA. Subtract net interest expense. Calculate taxes on pre-tax income (EBITDA minus D&A minus interest, times the tax rate), not on EBITDA itself. Adjust for working capital changes: increases in receivables and inventory are cash outflows, increases in payables are inflows. Subtract capex. The result is levered free cash flow, which represents cash available to equity holders after all operating costs, interest, taxes, and reinvestment.

"Why is EBITDA not a good proxy for cash flow?"

Because it ignores four significant cash items: taxes, interest, working capital requirements, and capital expenditure. A company with £100M of EBITDA might generate only £30-50M of actual free cash flow after these deductions. EBITDA is useful as a quick operating profitability measure and for calculating EV/EBITDA multiples, but it should never be confused with cash available to investors.

"A company has high EBITDA margins but poor FCF conversion. What could explain this?"

High capex intensity (the business requires heavy reinvestment to maintain its asset base). Large working capital requirements (long receivable collection cycles or high inventory levels). High interest burden from heavy leverage. Or significant lease obligations under IFRS 16 that are excluded from EBITDA but represent real cash outflows. Any of these can produce a wide gap between EBITDA and FCF.

Take Your Preparation Further

Download our free Financial Ratios Cheat Sheet for FCF conversion ratios, capital intensity metrics, and cash quality analysis. For the complete valuation framework including DCF methodology, see the Valuation Cheat Sheet.

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EBITDA to Free Cash Flow: The Bridge, the Tax Trap, and the Lease Accounting Wrinkle