Thread by @IAmOanaLabes

Top 10 EBITDA Flaws You Should be Aware of and Beware

How many did you already know about?

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1️⃣ EBITDA is not a standardized GAAP metric, which means there is wide variation in how it is calculated.

- There's no standardized formula for calculation, leading companies to calculate it in a way that benefits them the most

- Stock based compensation for example may be included in EBITDA by some analysts and excluded by others. It can also be estimated in several ways which will change the expensed amount

2️⃣ EBITDA implies that all net income converts to cash equally, which is not accurate.

- EBITDA is a proxy for operational cash flow, but not a direct measure of it
- It ignores the required investment into working capital assets to support future growth
- It also doesn't consider the timing and nature of revenue recognition and accrued expenses

3️⃣ EBITDA does not consider the required capital reinvestment

- While Depreciation and Amortization are non-cash items, CAPEX investments aren't captured in EBITDA

4️⃣ It does not account for cash absorbed into working capital assets

- Changes in receivables, payables, and inventory balances can lead to a distorted view of operating cash flow

5️⃣ EBITDA implies that loan repayment is prioritized, which may not be the case

- Companies may use cash for growth, acquisitions, or capacity expansions instead, leaving no residual capital for loan repayment

6️⃣ It doesn't reflect the quality of earnings, leading to potential inflation.

- Earnings and EBITDA may be inflated with deferred expenses, aggressive accounting policies, or underfunded pension liabilities

7️⃣ EBITDA is a poor measure of profitability due to differing accounting standards.

- GAAP revenue recognition criteria vary worldwide, which can overstate earnings

8️⃣ EBITDA is inadequate for comparing acquisition multiples, as it doesn't capture industry-specific requirements

- It doesn't account for industry-specific capital investment needs or company-specific underlying strength in operating earnings

9️⃣ EBITDA can be misleading as a measure of cash flow due to its ignorance of real cash outflows

- It ignores several real cash outflows and understates the future expected increase of those cash outflows
- Interest and taxes are real cash outflows that reduce earnings in practice

🔟 EBITDA can be easily manipulated through aggressive accounting policies.

- Management can manipulate earnings and inflate EBITDA through a variety of methods, including:

☑️ aggressive percentage of completion revenue recognition

☑️ deferring expenses

☑️ understating pension liabilities

☑️ understating provisions

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