Why is EBITDA used in many groups as a proxy for cash flow from operations and performance? In adding back D&A doesn't that obscure the costs, albeit non-cash, borne by companies in generating their revenue? In the telecom sector, for example, EBITDA would probably not mirror CFO given the high levels of D&A.
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you mentioned the answer
you mentioned the answer yourself, its a proxy for cash flow not profitability.
you can have profitable companies that end up going into bankruptcy cause they can't manage cash flow. EBITDA just serves as a quick proxy for that.
each industry uses industry-specific metrics.
D&A is already factored into
D&A is already factored into the SG&A line item?
Cuz otherwise it doesnt make sense to me why add D&A into EBIT.
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D&A is already factored into the SG&A line item?
Cuz otherwise it doesnt make sense to me why add D&A into EBIT.
D&A may be either included in SG&A or broken out separately - but obviously, D&A has been removed by the time you reach EBIT.
Aside from the obvious
Aside from the obvious convenience factor, EBITDA may also be used since the traditional definition of FCF doesn't necessarily reveal a company's "true" free cash flow.
For example, one could argue that a company's maintenance capex is unavoidable, while its growth capex may be more discretionary in nature.
True WRT to classifying
True WRT to classifying growth capex as discretionary, but even still EBITDA's ignoring the maintenance capex, changes in NWC and cash taxes paid. It's a pretty poor proxy for FCFF. But sure, it's quick and dirty.
Owner Earnings
That's why Buffett uses Owner earnings:
If we think through these questions, we can gain some insights about what may be called "owner earnings." These represent (a) reported earnings plus (b) depreciation, depletion, amortization, and certain other non-cash charges such as Company N's items (1) and (4) less ( c) the average annual amount of capitalized expenditures for plant and equipment, etc. that the business requires to fully maintain its long-term competitive position and its unit volume. (If the business requires additional working capital to maintain its competitive position and unit volume, the increment also should be included in ( c) .
http://www.berkshirehathaway.com/letters/1986.html
Read through the whole appendix.
Buffett at 2002 annual meeting:
It amazes me how widespread the use of EBITDA has become. People try to dress up financial statements with it.
We won't buy into companies where someone's talking about EBITDA. If you look at all companies, and split them into companies that use EBITDA as a metric and those that don't, I suspect you'll find a lot more fraud in the former group. Look at companies like Wal-Mart, GE and Microsoft -- they'll never use EBITDA in their annual report.
People who use EBITDA are either trying to con you or they're conning themselves. Telecoms, for example, spend every dime that's coming in. Interest and taxes are real costs.
Depreciation and
Depreciation and Amortization are non-cash items, so there is no physical cash lost when accounting for these items - they are added back because you're assessing how much cash you have on hand, not your accounting profit.
In the case you have high Dep and Amortization, you generally have high capex, so the best thing to do is to calculate free cash flow and take out some level of maintenance capex (which would be high in telecoms) and then get a free cash flow amount. That's the difference between Cash flow from operations on the statement and calculating 'free cash.'
Unlevered FCF and Multiples
The real purpose of EBITDA is as a proxy for unlevered FCF.
Basically with EBITDA, D&A, an assumption around maintenance capex and working capital you have a DCF model. Since EBITDA should be used in a multiples based approach to comparable businesses these additional numbers should be very similar. Thus regardless of the chosen capital structure you can compare a business and see how it is valued on a TEV basis.
Some businesses don't trade on EBITDA, it may be completely useless. REITs trade on FFO and cap rates, many businesses trade on PE multiples, you can value power plants on a $/MW, and so on.
In general each sector has its own relevant multiple and you should apply it. Warren Buffet saying that companies that dress up their statements with it is a little snide an naive, mostly because thats only the case for companies where it isn't a relevant metric. Don't look at EBITDA for a telecom, or any obscenely high capex business. Likewise don't look at yield for a telecom.
Put some thought into how a sector can be compared on an apples to apples basis and use that.
it's all about capital
it's all about capital intensity
http://longorshortcapital.com/translating-corporate-speak-wynn-unforesee...
You guys are all correct
Except you're all missing the big picture as well.
The big reason to strip out D&A, Taxes, Interest, which are all real costs, is that those are non-operations costs. Senior management of a company can easily change those numbers in a quarter by changing around the balance sheet. EBITDA gets to the true operations of a company.
EBITDA, theoretically at least, gets to the fundamentals of a business. When you try to compare how well run Company A versus Company B is, who the hell uses net income margins?
PowerMonkey and gNt are
PowerMonkey and gNt are right, the point is to be able to find a metric that you can compare two companies on, regardless of capital structure.
I don't think anybody's
I don't think anybody's missing the big picture.
I think most ppl here understand the reasons for using EBITDA as a proxy for FCF, but the question then becomes why use the proxy? It's quick and dirty.
That still doesn't make it a great proxy for FCF. There are much better ways to come up w/ FCFF.
Isn't EBITDA a good proxy
Isn't EBITDA a good proxy because it exhibits the capital structure a company can support? Since it shows Earnings without Interest, Taxes, D&A, it exhibits the level of leverage a firm can sustain and thus shows the potential/performance of the company stripping away the effect of the current capital structure?
asdf
just pray the firm pays high and sustainable dividends and use the DDM approach
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I don't think anybody's missing the big picture.
I think most ppl here understand the reasons for using EBITDA as a proxy for FCF, but the question then becomes why use the proxy? It's quick and dirty.
That still doesn't make it a great proxy for FCF. There are much better ways to come up w/ FCFF.
Agree wholeheartedly.
Very surprising how many responses have been posted to such a basic question.
EBITDA is extremely useful
EBITDA is extremely useful as it dulls down the financial statements to a level in which non-finance majors like myself can understand, making myself more likely to find employment in related fields.