Earnings Before Interest, Tax, Depreciation & Amortisation has been a popular method of judging a business for many, many years. It is a measure that is used by people who can’t be bothered to understand the business properly and want a quick answer.
At a conference Warren Buffet and Charlie Munger, a team who have made a bob or two over the years from analysing accounts were asked what they thought of EBITDA. The answer from Mr Munger was short, dismissive and used words that are not suitable in a blog such as this dear reader.
If EBITDA is of no use to them then it is of no use to us. EBITDA died as an effective measure a long time ago.
They are of course absolutely correct. The idea of EBITDA is to put accounts onto a similar comparative basis and as such shows that the person using them does not really understand the businesses. You can only directly compare two things when they are the same. All businesses and organisations are different. It’s no point me trying to compare the two runners by putting them back to the point at which they were directly measurable before one invested in a personal trainer and the other invested in a couch, a flat screen tv and a lifetime supply of crisps but that’s what EBITBA does. It makes all investment decisions in a business equal in value. It ignores the ultimate goal of the business.
Effective people look at the business or organisation in total. Most importantly they look at the future, not the past in the way that those who study accounts and especially EBITDA do. Increasingly in a world where effective investment is the only way forward and interest rates unstable we need to understand why we have the interest and depreciation in the accounts and not just the numbers.
Don’t forget, it may well mean that the company with high interest and high depreciation has invested for the future and is about to rush into the lead as against the company that has not invested. EBITDA does not show us this. Alternatively the company that has invested may have gone too early and the business with low interest and depreciation may be the one waiting to pounce. EBITDA does not show us this.
If you want to judge a book then don’t pay attention to the cover but judge the contents. If you want to judge an organisation then do the same. The contents always mean more than the wrapper.
That’s why effective people never judge use EBITDA to judge a company.
The same is true, by the way when judging people but that’s another blog.
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