Disadvantages of EV/EBITDA

[FrankCFA]

• If working capital is growing, EBITDA will overstate CFO

Why…

[Tommy83]

When working capital is growing (mostly A/R and Inventory), it’s a use of cash. EBITDA doesn’t factor in working capital; EBITDA is simply operating profit plus non-cash charges (primarily depreciation and amortization).

One of the clearest examples of this is companies that show strong EBITDA growth, but they have a very large growth in Accounts Receivable at the same time, meaning the sales and profits that are reflected in EBITDA aren’t actually generating cash flow but instead are receivables.

[FrankCFA]

@Tommy83

When working capital is growing (mostly A/R and Inventory), it’s a use of cash. EBITDA doesn’t factor in working capital; EBITDA is simply operating profit plus non-cash charges (primarily depreciation and amortization).

One of the clearest examples of this is companies that show strong EBITDA growth, but they have a very large growth in Accounts Receivable at the same time, meaning the sales and profits that are reflected in EBITDA aren’t actually generating cash flow but instead are receivables.

Many thanks! It’s helpful.