Ebitda, (Earnings Before Interest, Taxes, Depreciation and Amortization according to its acronym in English and Earnings before Interest Taxes, depreciations and amortizations in Spanish), is an indicator with increasing use both as a management control tool, as well as, to decide an acquisition. Its moment of great diffusion was, accompanying the fury of acquisitions and mergers of the 80s and 90s.
For many it is considered one of the key indicators, to know the economic performance of a company, and it is used assimilating it to a value of "Cash flow" and thus determining the ability to generate cash, hence it is also the basis of measurement to decide acquisitions. However, it is no more than a partial, approximate measurement, and with some limitations that should circumscribe its application.
Main Limitations
The specialized technical literature, whether through books or articles referring to the potentialities and limitations, coincides in marking as a confusion that it is considered as an indicator of the evolution of the cash register; as:
- The financial effect of interest and taxes should not be ignored, although for some cases of need for comparison between companies it can be a very useful exercise to separate them from the result. It does not take into account that cash is often affected by movements in the assets or liabilities that are not reflected in the income statement, (cancellation of liabilities, activation of expenditures). It does not reflect the changes in working capital produced as a need generated by the moment of the economic cycle. The predictive ability of this indicator (considering multi-year projections, multiplying the annual EBITDA by the “n” years covered by the projection) to forecast the evolution of the cash also depends largely on the type of industry in which the company operates in particular,and the moment of the investment cycle - recovery in which it is. Since if it is an activity that requires permanent renewals of fixed assets, (for example companies in technology areas), the cash will be almost permanently impacted by the needs to maintain installed capacity according to the standard productive parameter, of the industry in which the company performs. For other activities that should not meet the requirement of frequent renewal of assets, it should be considered that; the correction to eliminate the effect of the pure accounting charges depends on the fact that the effective consumption of the assets must be such that it is not necessary to carry out reinvestments to sustain the productive capacity, within the projection term.Since if it is an activity that requires permanent renewals of fixed assets, (for example companies in technology areas), the cash will be almost permanently impacted by the needs to maintain installed capacity according to the standard productive parameter, of the industry in which the company performs. For other activities that should not meet the requirement of frequent renewal of assets, it should be considered that; the correction of eliminating the effect of the pure accounting charges depends on the fact that the effective consumption of the assets must be in such a way that it is not necessary to carry out reinvestments to sustain the productive capacity, within the term of the projection.Since if it is an activity that requires permanent renewals of fixed assets, (for example companies in technology areas), the cash will be almost permanently impacted by the needs to maintain installed capacity according to the standard productive parameter, of the industry in which the company performs. For other activities that should not meet the requirement of frequent renewal of assets, it should be considered that; the correction of eliminating the effect of the pure accounting charges depends on the fact that the effective consumption of the assets must be in such a way that it is not necessary to carry out reinvestments to sustain the productive capacity, within the term of the projection.impacted by the need to maintain installed capacity according to the standard productive parameter of the industry in which the company operates. For other activities that should not meet the requirement of frequent asset renewal, it should be considered that; the correction of eliminating the effect of the pure accounting charges depends on the fact that the effective consumption of the assets must be in such a way that it is not necessary to carry out reinvestments to sustain the productive capacity, within the term of the projection.impacted by the need to maintain installed capacity according to the standard productive parameter of the industry in which the company operates. For other activities that should not meet the requirement of frequent asset renewal, it should be considered that; the correction of eliminating the effect of the pure accounting charges depends on the fact that the effective consumption of the assets must be in such a way that it is not necessary to carry out reinvestments to sustain the productive capacity, within the term of the projection.It depends on the fact that the effective consumption of the assets must be in such a way that it is not necessary to carry out reinvestments to sustain the productive capacity, within the projection term.It depends on the fact that the effective consumption of the assets must be in such a way that it is not necessary to carry out reinvestments to sustain the productive capacity, within the projection term.
Even with Assets whose consumption is long-term, the analysis must be carried out at a time in the cycle that allows to foresee that investments in fixed assets will not be required.By considering an accounting result without being subjected to any composition analysis, the projection can be made on a base that contains non-repeatable concepts.
The main uses and limitations
In both acquisitions and management control, EBITDA is used as an indicator of cash performance.
Originally, it was a key element in deciding acquisitions made with “leverage” (purchases in which the price is paid totally or partially with the cash of the same company); using it as an indicator of indebtedness to estimate the potential coverage to take on debt from the company to be acquired, a central fact in this type of operation.
Some American banks also used it; But it was not enough to foresee that, according to some private studies, many of these companies went bankrupt within one to two years.
However, its use transcended this area and its application was generalized first to other operations (investments in dot com companies) and then as a performance measurement standard.
However, it only measures the result of the basic operations of the company, and in a horizon or time frame from short to medium term.
I. Limitations with respect to acquisitions
The set of limitations mentioned above constitute the reference framework for this indicator, so when using it as a support for acquisition or investment decisions it is important to note that:
- Payback Time Return and Risk
It is not possible to determine or support conclusions from it alone.
II. Limitations regarding Management control
To carry out management control, in which it is sought to know the performance of the company, there is also a limited indicator, since it does not summarize the set of conditioning factors, and other indicators must also be used to complete an overall vision and a correct composition of place. Without forgetting that it is highly vulnerable to aggressive accounting policy decisions, understood by these, to those accounting decisions that the management of a company adopts in order to force the indicators with which its management will be evaluated; and in many cases decided the prizes (bonuses).
These "aggressive Accounting Policies" we must remember that they can not only be used discretionally for this but to modify any index, indicator or information (remember for example the infamous Enron case), therefore the "management gurus" used by a few Indicators without having an adequate global vision of companies or economic groups are vulnerable in decision-making, so it is necessary to have sufficient objective elements for making adequate decisions.
Note:
For opinionable issues, they tend to favor the activation of charges, which then impact the income statement as amortizations, which are deducted to calculate the indicator.
