In this episode: David and Eric discuss EBITDA’s limitations and adjustments and why they are so important to understanding your business’ value.

We also discuss some critiques of using EBITDA including the famous one from one from Charlie Munger, Warren Buffett’s longtime business partner who boldly stated: “I think that every time you see the word EBITDA, you should substitute the word ‘bull#%$#’ earnings.”

While we aren’t as critical as Mr. Munger of EBITDA and do think it has valid uses, a clue as to why he might say such a thing comes from his partner, Warren Buffet, in his 2000 shareholder letter, “does management think the tooth fairy pays for capital expenditures?”

You can read a more expanded view of the benefits and shortcomings of EBITDA here:

https://www.emergedynamics.com/post/your-ebitda-multiple-is-misleading-you

Even though it has limitations, it is the most prevalent metric in valuation and business valuation and for good reason. We will discuss its capabilities and limitations. EBITDA is often touted as a proxy for cash flow but it really isn’t. One of its biggest limitations is that it doesn’t capture needed capital expenditure.  For businesses that are capital intensive – there’s a huge impact on cash flows and business value that EBITDA will never pick up.

EBITDA almost always needs to be adjusted after it is properly calculated from the income statement.  There are numerous things that could be adjusted.  Anything that a business is paying for that is above or below market needs to be adjusted. The most common example of this owner compensation.  Some owners don’t pay themselves at all while others may themselves enormous amounts.  This will have a large impact on perceived business value. 

Another example of something that needs to be adjusted is unusual or one-time expenses.

We discuss several examples and the importance of working with a seasoned M&A advisor, investment banker, or business advisor to go through each one.