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Summary
What is EBITDA?
EBITDA stands for earnings before interest, taxes, depreciation, and amortization.
EBITDA came into wide use among private capital firms, wanting to calculate
what they should pay for a business.
The private capital firms that originally employed EBITDA as a useful valuation
tool removed interest, taxes, depreciation, and amortization from their earnings
calculations in order to replace them with their own presumably more precise
numbers:
They removed Taxes and Interest because they wanted to substitute their
own tax-rate calculations and the financing costs they expected under a
new capital structure.
Amortization was excluded because it measured the cost of intangible
assets acquired in some earlier period, including goodwill, rather than
any current expenditure of cash.
Depreciation, an indirect and backward-looking measure of capital expenditure,
was excluded and replaced with an estimate of future capital expenditure.
Later, many public companies, analysts and journalists have urged investors
to also use EBITDA to measure the cash which public companies generate. EBITDA
is often compared with cash flow, because it rightfully adds back to net income
two major expense categories that have no impact on cash: depreciation and
amortization.
Why EBITDA can be misleading
Yet EBITDA is a very poor and even misleading mechanism if it is used to
approximate cash flows of public companies! Why?
It excludes taxes and interest, which are real cash items and
not at all optional. A company must of course pay its taxes and loans.
It does not exclude all non-cash items. Only depreciation and
amortization are excluded. Among the non-cash items not adjusted for in
EBITDA are bad-debt allowances, inventory write-downs, and the cost of stock
options granted.
Unlike proper measurements of cash flow, EBITDA ignores changes in
working capital. Additional investments in working capital consume
cash.
Finally, the main flaw of EBITDA is in the E (Earnings). If a
public company has over- or under-reserved for warranty costs, or for restructuring
expenses, or for bad-debt allowances, its earnings will be skewed. Its EBITDA
will be misleading. If it has recognized revenue prematurely or disguised
ordinary costs as capital investments, its reports are suspect. If it has
inflated revenue through round-trip asset trades, the E is of no informational
value.
Book: Steven M.
Bragg - Business Ratios and Formulas : A Comprehensive Guide
Book: Ciaran Walsh
- Key Management Ratios
Special Interest Group
Earnings Before Interest, Taxes, Depreciation and Amortizati Special Interest Group.
Forum discussions about Earnings Before Interest, Taxes, Depreciation and Amortizati.
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Calculate the EBITDA on a US GAAP basis
Can anyone help me? I need to calculate the EBITDA on a US GAAP basis, i'm using Mexican GAAP. Is there is a diferent formula to calculate it?...
EBITDA helps in merger and acquisition
Just to shed some light on EBITDA and EBIT, they help in merger and acquisition as they reveal the earning capacity of a company....
EBITDA for Aluminium Manufacturer
Can anyone please suggest me how do we calculate EBITDA for aluminium manufacturing company? Or is it correct to say quantity*NEP-total cost=EBITDA?
WHERE NEP=net effective premium.....
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EBITDA growing in Europe
A recent PwC survey based on analysis of 2,800 European financial statements found the following slightly growing percentages of companies of using EBITDA or similar measures (EBITA, EBITAE and EBITDA...
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