RMK,
Back in the good old days of having a beer with Alan Bristow, profit was what counted, not earnings and yes, I’m well aware of what the E in EBITDA stands for, having been sent on courses by the bean counters to be able to decipher their TLAs and FLAs. However, I also learned that it is a very poor and misleading mechanism if it is used to get an idea of the cash flow of a public company because:
1. It excludes taxes and interest, which are real cash items and not at all optional—a company must obviously pay its taxes and loans.
2. On the other hand, it does not exclude all non-cash items, only depreciation and amortization. Among the non-cash items not adjusted for in EBITDA are bad-debt allowances, inventory write-downs, and the cost of stock options granted.
3. Unlike proper measures of cash flow, it ignores changes in working capital. Additional investments in working capital consume cash.
4. Finally, the main flaw of it is in the E (Earnings). If a public company has over- or under-reserved for warranty costs, restructuring expenses, or bad-debt allowances, its earnings will be skewed and its EBITDA misleading. If it has recognized revenue prematurely or disguised ordinary costs as capital investments, its numbers are suspect. If it has inflated revenue through round-trip asset trades, the E is of no informational value.
I’m just a poor old retired dinosaur, but my other half is involved in investigating fraudulent bean counters and when I mentioned this to her, she told me that a lot of failing businesses focus on highlighting EBITDA because it minimizes the impact of factors outside of their scope of control and focuses only on what can be controlled.