EBITDA a quick note august 2015

1. www.futurumcorfinan.com
Page 1
EBITDA : A Quick Note
I do hope using EBITDA don’t move to
become “EIATBS” (E-at-b-s) as Earnings Ignoring All The Bad Stuffs”….
So what is EBITDA?
In M&A world, we in general will hear people start talking about EBITDA (pronounced:
e..bit…da1
), that is Earnings Before Interest, Tax, Depreciation and Amortization. Though is
a very common language in M&A world, yet, I am not too sure whether people really understand
this very well.
EBITDA is said closer to the value added generated by Operating Cycle, as demonstrated
below2
.
1
Read also article by Herb Greenberg in Fortune Magazine (June 22, 1998), “EBITDA: Never Trust
Anything That You Can’t Pronounce”.
2
Vernimmen, Pierre; Pascal Quiry; Antonio Salvi; Maurizio Dallocchio; dan Yann LeFur. Frequently Asked
Questions in Corporate Finance. West Sussex: John Wiley & Sons Ltd. 2011. Page 20.
Sukarnen
DILARANG MENG-COPY, MENYALIN,
ATAU MENDISTRIBUSIKAN
SEBAGIAN ATAU SELURUH TULISAN
INI TANPA PERSETUJUAN TERTULIS
DARI PENULIS
Untuk pertanyaan atau komentar bisa
diposting melalui website
www.futurumcorfinan.com

2. www.futurumcorfinan.com
Page 2
There are a couple of things that I don’t really like using EBITDA…(again cash flow is a fact and
EBITDA is an opinion).
First, EBITDA does not include “depreciation” as part of the operating costs. Yes, it is TAKEN
OUT, NOT CONSIDERED. The main reason is “depreciation” is not a real cash cost…it is an
accountant’s way to allocate the cost, so it is based on cost allocation concept. The cost has
been spent in the past and it is not relevant again. Yes, it is said, depreciation is not
RELEVANT, it is a sunk cost.

3. www.futurumcorfinan.com
Page 3
Ok, I don’t want to argue with the bean counter, but…to me, whatever it is, depreciation, yes is
not CASH cost, but still it is a REAL COST (see the only difference is the word “CASH”), and it
is not much different with other costs, such as the employees’ payroll expenses. Depreciation is
closely linked to the use of the fixed tangible assets and as many things that are tangible in this
real world, everything will wear off. For example, plants will rust somehow, and the production
machine in that plant will be obsolete someday. Capital spending might also be producing over-
capacity. Whether you like or not, all those fixed tangible assets will need someday to be
replaced or refurbished. Depreciation “expense” indeed recognizes this “cost”.
Analysts are pushing further to approximate EBITDA as “Cash Flow”. Be careful, EBITDA WILL
NEVER BE THE SAME WITH CASH FLOW. Why not just jump to using cash flow from the
Cash Flow Statement, instead approximating EBITDA with cash flow?
We need to remember that EBITDA is used because analyst wants to have something simple to
use instead of calculating or identifying the unlevered cash flow from operations, but again this
is a very rough approximation. EBITDA indeed can be quite misleading as a measure of the
cash flow. We can see this easily and quick. EBITDA ignores all accruals (particularly working
capital, etc.) and further, it ignores the taxes on operations result. As we know, tax is something
that the company can’t run from……then why EBITDA is used?
In EBITDA, depreciation and amortization is taken out, as in certain industries, such as
broadcasting, where depreciation charges may be said overstating “true economic
depreciation”3
. However, interesting to see what Warren Buffett said about EBITDA:
Treating EBITDA as equivalent to earnings is tantamount to saying that a business is the
commercial equivalent of the pyramids – forever state-of-the-art, never needing to be replaced,
improved, or refurbished. In Buffett’s view, EBITDA is a number favored by investment bankers
when they cannot justify a deal based on EBITDA.
Too much focus on EBITDA will able to drag us away from 2 (two) critical business drivers, that
is (i) ROCE (Return on Common Equity) and (ii) the amount that the common shareholders
have invested in the company, that is the amount of the book value of the common equity (=
assets minus liabilities). In other words, the company increases its value over book value of the
equity by increasing its ROCE above the cost of capital, and they could further increase their
3
About “Economic Depreciation”, refer to Zvi Bodie in “Compound Interest Depreciation in Capital
Investment,” Harvard Business Review, 60 (May-June 1982), page 58-60.

4. www.futurumcorfinan.com
Page 4
value by growth in the book value of the equity that will earn at this ROCE, as shown in the
Value Matrix below.
Second, as EBITDA takes out depreciation and amortization for its measurement, there is a
hidden trick that accountants could do to improve the company’s EBITDA in current period and
also in the future periods. Knowing that expensing certain charges could lower current EBITDA,
then to save current EBITDA, the accountants could capitalize all those charges. This will surely
increase the current EBITDA. Not only current period EBITDA. All those capitalized charges
when are amortized in the future periods, will not impact the EBITDA as well, since all those
amortization charges will not be reflected in the EBITDA number in any period in the future.
See, it is not difficult to make the EBITDA look good…..
I want to close off this short writing with again what Warren Buffett touched on EBITDA.
August 2015
~~~~~~ ####### ~~~~~~

5. www.futurumcorfinan.com
Page 5
Disclaimer
This material was produced by and the opinions expressed are those of FUTURUM as of the date of
writing and are subject to change. The information and analysis contained in this publication have been
compiled or arrived at from sources believed to be reliable but FUTURUM does not make any
representation as to their accuracy or completeness and does not accept liability for any loss arising from
the use hereof. This material has been prepared for general informational purposes only and is not
intended to be relied upon as accounting, tax, or other professional advice. Please refer to your advisors
for specific advice.
This document may not be reproduced either in whole, or in part, without the written permission of the
authors and FUTURUM. For any questions or comments, please post it at www.futurumcorfinan.com
© FUTURUM. All Rights Reserved