The EBITDA solution in assessing company value and multiples can be a general accepted metric or a general accepted virus?
Unitill quite recently EBITDA is used as operating cash flow "proxy" althout it is not the same number. One mgh wonder, why don't use the declared and publicly disclosed value under the operating cash flow instead ?
Initially, there were rare and isolated cases of EBITDA uses that appeared in some situations but now it is allover the place in the world resambling like a virus for accountants regarding company valuation for its adaptability "case-by-case" and manipulating flexibility. Another question arise here, why using such a metric in benchmarking analysis when peers adopts different accounting policy in amortization and depreciation ?
The EBITDA is endangering rational though about accounts and company valuation across the civilised world. In case You have been fortunate enought to escape contact with it, the EBITDA is earnings before interest taxes and depreciation and amortization.
Some elements of it makes sense in certain circumstances , if you want a check over companys "operating performance" thant it is perfectly reasonable to ignore taxes interests and amortization of goodwill. If you want to assess company value while keeping an open mind about how it is financed then it is sensible to ignore interests.
What does not make sense is a comment such as "at 12 times EBITDA company "ABC" is out of line with its peers". Sell it and buy company "X&Y" instead with 8 times EBITDA since the industry median is at 10x. Unfortunately, that is exactely the kind of comment that you will see daily (except of course that no analyst who wants to keep is job ever actually tells you to sell anything).
A simple answer would be "You can't judge a book by its cover".
A more technical answer also given in the accountancymagazine would be that there are 2 major problems with using "EBITDA". The first is that no assessment of a business should ever ignore the costs of its fixed assets. FA are as much an operating costs as any other. The only difference between them and other operating costs is that their consumption is spread over more then one accounting period. It beggars believe that serious commentators should be ignoring these costs for any purpuse whatever let alone for making valuation.
The second big objection to EBITDA is that it is miles away from the bottom line.
Depreciation, interests and taxes are all real and effectively recurring costs. They should be taken into account in assessing a company's performance and its value (amortization of goodwill is arguably a real cost too, but as there's some doubt about it will leave it aside).
The further you get from bottom line, the easier it is to kid yourself about how well a company is really doing. Even cronic loss makers can be made to look like healthy investments by focusing on EBITDA. Maybe Analysts think that EBITDA is free from accounting judgments.
As our accounting solution page this month shows that would be a mistake.
The Focus on EBITDA has simply made it into a target for manipulation, like any other accounting figure.
There is no escape from strathern's law - that when a measure becomes a target it cases to be a good measure. The sensible course of action is to decide what figure would ideally provide the best measure and then put in place appropriate defencies to ensure its integrity. Sush a audit accounting standards and so on.
In assessing a business the starting poin should be the bottom line and every move away from that should be viewed with suspicious. Valuation based on EBITDA reflect only part of a Business financial performance and can be right only by coincidence.
Talking about covenants and Interests coverage, the "EBITDA/Interest" is forward-looking liquidity test because some Bankers believes it shows cash coverage potential without considering that it is a more forgiving metric for high-depreciation industries (high depreciation industries accounts depreciations and amortisations equal or higher than 30% of the overall fixed assets). It is focused on the liquidity & the cash generation capacity and it is favoured by credit rating agencies. Better in CAPEX-heavy industries. So one may argue, why do not use the operating cash flow disclosed number instead ?
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