More on EBITDA

BY MATTHEW D. MOHR

Readers will recall my previous articles discussing the financial measurement value of earnings before interest, taxes, depreciation, and amortization (EBITDA). I do not regard EBITDA as a reliable or consistently usable financial tool. Recently, a relatively new venture showed its first significant quarterly profit, but the company highlighted its EBITDA most prominently in its financial review to investors. The current quarter’s net income was a major milestone for the company but EBITDA looked like a much better number, until one dug a little deeper.

EBITDA generally is used to show how much, if all else fails, the likely cash flow should be to cover debt payments of an enterprise. In this particular case the enterprise has burned through the bulk of its investors’ capital so earnings on the remaining net worth are reasonable. EBITDA in the quarter was many times larger than reported earnings, so management chose to show how big its EBITDA was rather than focus on obtaining profit. But the enterprise is young enough to still need cash and cash required due to non-expense needs is still high, so EBITDA didn’t even begin to represent the ability to repay debt.

Outside of debt repayment, the enterprise’s quarterly EBITDA, if it was cash flow, would take 10 years to cover the equity already expended! Success was really showing a profit. Focusing on EBITDA demonstrated management’s lack of financial ability and understanding.

EBITDA is not a reliable measure of financial soundness, and should not be the focus of financial review or management objectives. Only cash flow and real profitability are meaningful financial measures of success. PB

Matthew D. Mohr CEO, Dacotah Paper Co. mmohr@dacotahpaper.com