Profitability performance indicators

Question 1

What is EBITDA?

Answer 1

Earnings before income tax depreciation and amortization (and write off’s such as good will)

Question 2

What are the advantages of EBITDA?

Answer 2

+ Measure of underlying performance since it is a proxy for cash flow generated from operating profit
+ Tax and interest are externally generated and therefore not relevant to the underlying success of the business
+ Easy to calculate
+ Easy to understand

Question 3

What are the disadvantages of using EBITDA?

Answer 3

• Poor correlation to shareholder wealth
• Hard to compare to other organisations due to differences in accounting policies
• Absolute figure - hard for comparison
• Ignores changes in working capital and their impact on cash flow
• Easy to manipulate by aggressive accounting policies related to income recognition and capitalization of expenses