Crash Course in Accounting and Financial Statement Analysis, Second Edition

EBITDA Has Several Shortcomings

Incorrectly used or a shortened measure of cash flow, EBIDTA does not take into account a company’s:

• Interest payments

• Capital expenditures (investments in fixed assets – cash out)

• Working capital (day-to-day cash requirements needed for a company’s ongoing operations)

EBIDTA can be manipulated to show a desired level of profitability. However, since it ignores debt payments, taxes, and capital expenditures, EBITDA can be used by companies as their primary level of profitability. However, this can be misleading if after taking into account those three obligations, companies may instead be losing money.

In addition, EBITDA is an inappropriate metric to use in industries such as cable and telecom, transportation, and energy because they are very capital-intensive. Using an EBITDA metric, which ignores a significant amount of capital expenditures undertaken by companies, may be inappropriate for these industries.

In the Real World: WorldCom in 2001 In 2002, WorldCom, a long-distance telephone company, admitted to accounting fraud. The company improperly recorded $3.86 billion in operating expenses as capital expenses instead of immediately recording a $3.8 billion expense by classifying the expense as capital expenditures (purchases of fixed assets) and depreciated them over their useful life, making the company’s expenses lower and EBITDA as well as earnings higher than they actually were during this period.

The Final Word on EBITDA EBITDA is a very ...