Data Driven Decisions

Chapter 6EBITDA Is Not the Best Way to Value Intangible‐Heavy Companies

EBITDA, as mentioned earlier, stands for earnings before interest, tax, depreciation, and amortization. EBITDA is a metric that is derived from an income statement or profit and loss statement and is meant to be a proxy for the cash flow of a business.

In most GAAP and IFRS accounting methods, net income or net profit is subject to deductions that are a result of non‐cash expenses.

Depreciation is a non‐cash expense that exists on an income statement that lowers a taxable net income but does not actually require money to cover the expense. An example of depreciation is when one buys a large machine – let us say, for the sake of an example, that the machine is worth a hundred dollars, and the machine is straight‐line depreciated over ten years at ten dollars a year, that machine would go from a value of one hundred dollars to ninety to eighty, seventy, sixty, and so on dollars per year and in ten years, the machine would be worth zero.

That depreciation expense is recorded on the income statement and deducted from taxable net income to help lower tax burdens for businesses based in the United States and Europe.

Amortization follows the same logic. It is a non‐cash expense for intangible assets. We will get into amortization more in this book when we talk about purchase price allocation. If you buy a patent, the patent has a useful life of ten years. You paid a hundred dollars for the patent. The patent is ...