Assessing EBITDA
EBITDA stands for "Earnings Before Interest, Taxes, Depreciation, and Amortization". It's a way of measuring a company's operating income before deductions.
Supporters of EBITDA find it useful for assessing the level of income generated by new or rapidly-developing companies (before non-cash charges, interest, tax and loan payments have been deducted). They also use EBITDA over a sustained period as a measure of an investment's longer term growth in profitability, and overall success.
EBITDA is also used to gauge the market value of a company—for example, in the run-up to an acquisition. In the case of leveraged buyouts (LBOs), EBITDA can help assess a company's ability to repay debt used to finance the transaction. Indeed, the concept of EBITDA first appeared in the 1980s when LBOs were increasingly commonplace.
The use of EBITDA (and EBIT) is controversial as an effective measure of operating cash flow—it has as many detractors as supporters.
Since it first appeared, EBITDA has been an increasingly popular tool in the telecommunications, cable and media industries. It is not a true measure of cash flow, as straightforward cash from operations would typically result in a far lower figure. The formula used is either:
or:
- There is no standard definition of EBITDA, so it runs the risk of being manipulated to suit the purposes of accountancy—thereby undermining its credibility.
- EBITDA takes no account of capital expenditure—in capital intensive industries such as manufacturing, transportation, and technology (particularly in the early phases), this could result in misinformation at the very least.
- Critics of EBITDA argue that: interest and taxes do require cash settlement; investors are further down the list of priorities than creditors; EBITDA takes no account of significant factors like working capital, loan repayments and other fixed expenses; it can present companies in an unjustifiably favorable light.
- However, investors and analysts may still find EBITDA helpful when comparing companies in the same sector that have different tax rates, and varying approaches to depreciation and capital structure.
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