EBITDA Pro’s and Con’s

Updated: April 06, 2010

EBITDA is calculated by taking operating income and adding depreciation and amortization expenses back to it. EBITDA is used to analyze a company's operating profitability before non-operating expenses (such as interest and "other" non-core expenses) and non-cash charges (depreciation and amortization).

Critics of EBITDA claim that it is misleading due to the fact that it is often confused with cash flow and factoring out interest, taxes, depreciation and amortization can make even completely unprofitable firms appear to be fiscally healthy. Looking back at the dotcom companies, there are countless examples of companies that had no hope, future or earnings and the use of EBITDA made them look attractive.

Also, EBITDA numbers are easy to manipulate. If fraudulent accounting techniques are used to inflate revenues and interest, and taxes, depreciation and amortization are factored out of the equation, almost any company will look great. Of course, when the truth comes out about the sales figures, the house of cards will tumble and investors will be in trouble. In the mid-nineties when Waste Management was struggling with earnings, they changed their depreciation schedule on their thousands of garbage trucks from 5 years to 8 years. This made profit jump in the current period because less depreciation was charged in the current period. Another example is the airline industry, where depreciation schedules were extended on the 737 to make profits appear better. When WorldCom started trending toward negative EBITDA, they began to change regular period expenses to assets so they could depreciate them. This removed the expense and increased depreciation, which inflated their EBITDA. This kept the bankers happy and protected WorldCom's stock.

Another concern is that EBITDA does not take into account working capital. It could be helpful to also point out that EBITDA is not a generally accepted accounting principal.

Because EBITDA can be manipulated like this, some analysts argue that a it doesn't truly reflect what is happening in companies. Most now realize that EBITDA must be compared to cash flow to ensure that EBITDA does actually convert to cash as expected.

To sum up the cons:

  1. EBITDA ignores changes in working capital and overstates cash flow.
  2. EBITDA can be a misleading measure of liquidity.
  3. EBITDA does not consider the amount of required investment.
  4. EBITDA ignores distinctions in the quality of cash flow resulting from different accounting policies.
  5. EBITDA deviates from the GAAP measure of cash flow because it fails to adjust for changes in operations-related assets and liabilities.

On the plus side, EBITDA makes it easier to calculate how much cash a company has to pay down debt on long term assets. This calculation is called a debt coverage ratio. It is calculated by taking EBITDA divided by the required debt payments. This makes EBITDA useful in determining how long a company can continue to pay its debt without additional financing.

Featured Research
  • The Social Side of Service

    Did you know that 83% of Twitter users who tweeted a complaint said they loved receiving a response from the brand? In order to provide the best possible service to your customers, you MUST provide service on the channels that they are utilizing. Social customer service might seem scary and undefined, but can be much more effective and less expensive than traditional channels. more

  • Video Conferencing

    For many, the mere mention of video conferencing brings about bad memories of conference rooms full of people staring at a screen with dodgy sound, fuzzy images, and broken connections. What if we were to tell you that over the past decade, video conferencing solutions have evolved to where they are affordable to businesses of every size and have evolved beyond just the standard boardroom. Today, 74% of B2C marketers and 94% of B2B marketers use video in their marketing efforts. more

  • EHR Implementation

    More and more medical practices are selecting and implementing electronic health records (EHR) than ever before. In fact, statistics show that the number of practices who have purchased an EHR has doubled in just three years. That being said, many practices fail to prepare for their new EHR and thus do not gain the full benefits that come with implementing a solution. more

  • Selecting the Right EHR for Your Practice

    The purchase and implementation of an electronic health record (EHR) system is no small feat and is a big step for a practice, small or large, to take. Selecting your new EHR is one of the most important decisions that you will make for your practice. more

  • 8 Ways Business Travelers Can Save with VoIP

    Do you or any part of your workforce travel for work, or even telecommute? If that answer is yes, then you should be utilizing mobile VoIP. With VoIP, businesses have been found to save as much as 40% on local calls and a whopping 90% on international calling expenses. more