Cash conversion: operating cash flow to EBITDA

Q: How is cash conversion calculated?

The common form is: Cash conversion = cash generated from operations ÷ EBITDA × 100 Cash generated from operations is the operating cash flow before interest and tax. That keeps the numerator on the same footing as EBITDA, which is also before interest and tax. Variants include using operating cash flow after tax, or deducting capital expenditure to give a "free cash" version, which links to free cash flow. None is wrong, but they give different answers, so the definition has to be stated and kept the same each year. There is no official definition. EBITDA itself is not defined in FRS 102, as explained in EBITDA explained. For IFRS reporters, IFRS 18, effective for annual periods beginning on or after 1 January 2027, introduces disclosure rules for management defined performance measures, but paragraph B116 says financial ratios and measures of liquidity or cash flows are not themselves such measures. Paragraph B117 adds that a subtotal used as the numerator or denominator of a ratio can be one, and paragraph 118(b) excludes operating profit before depreciation, amortisation and impairment from the rules. So an adjusted EBITDA used in a cash conversion ratio may need IFRS 18 disclosure, while the ratio itself does not.

Q: What explains a low or a high ratio?

Working capital growth. ACCA highlights large increases in receivables and inventories as a warning sign. A growing business will often convert less than 100% simply because it is funding more debtors and stock; slower collection shows up in debtor days. Stretching suppliers. ACCA also warns that a significant increase in payables may mean the company is delaying payment to suppliers to flatter its year end cash. Conversion above 100% for one year often reflects this or a one off release of working capital, and will reverse. Non cash items in EBITDA. Provision releases, accrued income and unrealised gains raise EBITDA without cash. Cash costs left out of adjusted EBITDA. Restructuring or deal costs paid in cash but added back to "adjusted EBITDA" depress the ratio unless they are treated the same way on both lines. Timing. A large receipt just before or after the year end can swing a single year's figure. Look at three or more years together. The pattern over time says more than any single result.

Cash conversion compares the cash a business generates from its operations with its EBITDA, usually as operating cash flow divided by EBITDA and shown as a percentage. A result close to 100% means earnings are turning into cash; a figure that stays well below that points to cash tied up in debtors and stock, or to profits that include non cash items. No accounting standard defines the ratio, so anyone quoting it should state exactly which cash flow and which EBITDA they used.

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How is cash conversion calculated?

The common form is:

Cash conversion = cash generated from operations ÷ EBITDA × 100

Cash generated from operations is the operating cash flow before interest and tax. That keeps the numerator on the same footing as EBITDA, which is also before interest and tax. Variants include using operating cash flow after tax, or deducting capital expenditure to give a “free cash” version, which links to free cash flow. None is wrong, but they give different answers, so the definition has to be stated and kept the same each year.

There is no official definition. EBITDA itself is not defined in FRS 102, as explained in EBITDA explained. For IFRS reporters, IFRS 18, effective for annual periods beginning on or after 1 January 2027, introduces disclosure rules for management defined performance measures, but paragraph B116 says financial ratios and measures of liquidity or cash flows are not themselves such measures. Paragraph B117 adds that a subtotal used as the numerator or denominator of a ratio can be one, and paragraph 118(b) excludes operating profit before depreciation, amortisation and impairment from the rules. So an adjusted EBITDA used in a cash conversion ratio may need IFRS 18 disclosure, while the ratio itself does not.

Where do the two figures come from in UK accounts?

Under FRS 102 Section 7, the statement of cash flows splits cash flows into operating, investing and financing activities. Paragraph 7.4 says operating activities are the principal revenue producing activities, so operating cash flows generally come from transactions that enter into profit or loss.

The useful part is the indirect method reconciliation. Paragraph 7.8 requires it to start from a measure of profit and adjust for changes in inventories and operating receivables and payables, non cash items such as depreciation, provisions and accrued income or expenses, and items whose cash effects are investing or financing. That reconciliation is, in effect, the bridge between EBITDA and operating cash flow, and it shows exactly why the two differ.

Two choices in Section 7 affect comparability. Paragraphs 7.14 to 7.16 allow interest paid, interest and dividends received and dividends paid to be classified as operating or as financing and investing, provided the choice is consistent. Paragraph 7.17 puts tax paid in operating activities unless it can be specifically identified with investing or financing. Before comparing a company’s net operating cash flow with EBITDA, check where interest and tax sit and strip them out if needed.

Small companies are not required to prepare a cash flow statement (paragraph 7.1B), so for most owner managed businesses the figure has to be built from the profit and loss account and two balance sheets. See cash flow statements for small companies.

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Why do lenders and buyers look at it?

ACCA’s guidance on analysing cash flows says cash generated from operations is effectively the cash profit from operations and should be compared with operating profit to show the quality of the profit: the closer the two, the better the quality. If profit is much larger than cash generated, the business is not turning profit into cash, which could lead to short term liquidity problems.

HMRC’s International Manual makes the same point from a lender’s angle. INTM516070 says EBITDA ratios are often used as a rough substitute for cash flow, by lenders and by HMRC, and lists the flaws: EBITDA relies on profit and loss figures that may reflect non cash items such as accruals and provision movements, it ignores debt repayments and capital expenditure, and working capital needs vary between periods. Cash conversion measures how good that substitute is for a particular business. INTM516080 describes adjusting EBITDA to cash flow by deducting items such as increases in working capital, tax paid and non cash credits, and adding non cash debits and reductions in working capital.

A business with strong EBITDA but weak conversion is worth less to a buyer and supports less debt than its EBITDA suggests, which feeds through to ratios such as net debt to EBITDA.

What does a worked example look like?

Illustration only. A company reports EBITDA of £500,000. During the year debtors rose by £90,000, stock rose by £30,000 and trade creditors rose by £20,000. A £10,000 provision was released, which increased profit without any cash coming in.

Step	£
EBITDA	500,000
Less increase in debtors	(90,000)
Less increase in stock	(30,000)
Add increase in creditors	20,000
Less provision released (non cash credit)	(10,000)
Cash generated from operations	390,000
Cash conversion (390,000 ÷ 500,000)	78%

If the analyst instead uses operating cash flow after £60,000 of tax paid, the figure becomes £330,000 and conversion falls to 66%. Neither is wrong; they answer different questions.

What explains a low or a high ratio?

Working capital growth. ACCA highlights large increases in receivables and inventories as a warning sign. A growing business will often convert less than 100% simply because it is funding more debtors and stock; slower collection shows up in debtor days.
Stretching suppliers. ACCA also warns that a significant increase in payables may mean the company is delaying payment to suppliers to flatter its year end cash. Conversion above 100% for one year often reflects this or a one off release of working capital, and will reverse.
Non cash items in EBITDA. Provision releases, accrued income and unrealised gains raise EBITDA without cash.
Cash costs left out of adjusted EBITDA. Restructuring or deal costs paid in cash but added back to “adjusted EBITDA” depress the ratio unless they are treated the same way on both lines.
Timing. A large receipt just before or after the year end can swing a single year’s figure.

Look at three or more years together. The pattern over time says more than any single result.

How does the 2026 lease accounting change affect it?

FRS 102 as amended in 2024 applies to periods beginning on or after 1 January 2026 (paragraph 1.37(b)). Under paragraph 20.45 a lessee now recognises a right of use asset and a lease liability for most leases. Paragraph 7.6(e) puts the principal part of lease payments in financing activities, and paragraph 7.15 treats the interest part as interest paid. Rent therefore leaves both EBITDA and operating cash flow, so both increase. Because the same amount is added to the top and bottom of the ratio, a business converting below 100% will see its ratio move towards 100% without any real change. Restate prior years before comparing. See the FRS 102 lease transition.

Is this the same as the cash conversion cycle?

No. The cash conversion cycle measures in days how long cash is tied up between paying suppliers and collecting from customers. Cash conversion as described here is a percentage comparing two annual figures. A lengthening cycle is one of the main reasons the percentage falls.

What mistakes come up most often?

Dividing operating cash flow after interest and tax by EBITDA, which is before both.
Using adjusted EBITDA on top and unadjusted cash flow below.
Comparing companies that classify interest or tax differently in their cash flow statements.
Judging a business on one year’s figure.
Ignoring capital expenditure, which can make a high conversion business still cash hungry.
Not stating the definition used.

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Reviewed by Christine Anderson, Broker, Solar Protect. Last reviewed 19 October 2026. Part of Accountapedia, the Solar Protect guide to UK tax and accounting. This page is general information, not personalised advice.