Cash conversion
LBOThe share of reported EBITDA that survives capital expenditure, working capital and cash tax, and therefore the figure that decides how fast a buyout can repay debt.
Also written: cash conversion rate, EBITDA to cash conversion
Cash conversion asks one question: of the EBITDA a company reports, how much can be used? Subtract the capital expenditure needed to keep the business running, the cash absorbed by working capital as it grows, and cash tax, and what remains is the amount available to pay interest and repay principal.
It is not the same as the margin, and this is where a management presentation and a debt schedule part company. Two businesses can report an identical EBITDA margin while one converts almost all of it into cash and the other spends most of it on plant and stock. The debt one of them can carry is far larger than the debt the other can.
The mechanism is direct. Debt is repaid out of the cash left after interest, so a business that converts poorly repays slowly, stays levered longer, and leans harder on the exit multiple for its return. That is the same as saying it leans harder on something the sponsor does not control.
It is also why growth can be a cash problem rather than a cash solution. A business growing quickly with a long working capital cycle can report rising EBITDA every year while consuming cash, which is precisely the profile that impresses in a meeting and fails in a model.
Worked example
Two businesses each report 100 of EBITDA on a 20% margin. The first needs 10 of capital expenditure and no working capital build, so it converts 90.
The second needs 35 of capital expenditure and adds 10 of working capital as it grows, so it converts 55. Before a single euro of interest, one has 90 to work with and the other has 55.
At an illustrative 6% coupon, the first can service and amortise far more debt than the second, and a lender will size the facility accordingly even though the reported margins are the same.