Popular as EBITDA is, here are some issues associated with using EBITDA that every investor should know.

What is EBITDA?

EBITDA stands for Earnings before Interest, Tax, Depreciation and Amortisation. By removing these expenses, EBITDA is commonly believed to be a proxy for free cash flow. In that regard, it allows investors to evaluate the cash-generating ability of companies.

As with every measure, EBITDA does have its flaws even if little heed is typically paid to it.

Non-Cash Does Not Mean Non-Economic

The main issue with EIBTDA lies in the omission of depreciation. While this may be acceptable for service-based businesses, depreciation is a very real, albeit non-cash, expense for the majority of businesses. Machines get worn out and need to be consistently maintained for the business to be sustained. Depreciation expenses must eventually be used to fund capital expenditures. A manager who distributes the ‘excess’ cash from depreciation will …