Use of EBITDA in M&A
Jaap de Jonge, Editor, Netherlands
EBITDA is indeed used a lot in M&A transactions in order to help determine the purchase price that will be paid. However it is important to understand the limitations to EBITDA when using it or EBITDA multiples for estimating value or pricing a business.
First of all, EBITDA is not a measure of financial performance calculated in accordance with generally accepted accounting principles (GAAP, IAS). So there is no general consensus as to its official calculation. In other words, its precise calculation may vary according to the accounting police of each company.
So yes, even if EBITDA is widely used as a measure of earnings capacity, it can easily be manipulated by adjusting a company's revenue and expenses through things like:
- Company accounting policies, such as revenue recognition, accounts receivable, reserves, etc.;
- The EBITDA calculation's lack of attention to changes in working capital and investing cash flows, such as capital expenditures, proceeds from asset sales, and cash expenses for liabilities already accrued, such as employees' vacation time accrued;
- Adjustments to earnings, in order to adjust for excess compensation, discretionary expenses and others.
That's why it is important to understand and account for these limitations of EBITDA when using it to value and price a business.