Magazine article Management Today

Keep Track of the Pounds

Magazine article Management Today

Keep Track of the Pounds

Article excerpt

Last year it was revenue multiples. Before that, EVA, market/book, EPS. Financial measures are as faddish as diets. Is the latest, Ebitda, any better?

What is Ebitda?

Earnings before interest, tax, depreciation and amortisation. It's the metric-du-jour for company performance and valuation. Investment bankers start corridor conversations with 'It's trading on 6 times Ebitda'. The French magazine L'Expansion just ran an editorial touting Ebitda as the new cure-all for the dot.com and TMT valuation bubbles -- no more revenue multiples or dollars per-eyeball (as with all things Anglo-Saxon, the French are a bit behind the curve).

Why is it now in favour?

It's a sort of proxy for operating cashflow. Start with after-tax profit. Add back interest and tax, to exclude the effects of gearing and tax management. Then add back depreciation and amortisation charges -- on the basis that these reflect historical investment decisions (like a factory re-fit three years ago, or old R&D),rather than current cashflow.

A good thing about Ebitda is that it's clearly a lot better than dot.com-era revenue multiples, which were really stupid. A bad thing about Ebitda is that, as an absolute measure of value or target for business performance, it's still stupid, although not as stupid as revenue multiples.

Why is Ebitda stupid?

I don't mind adding back depreciation and amortisation if I then deduct current-year cash capital spend -- what the business is actually paying out this year on new factory re-fits. R&D etc. That gets me to RGOOCF -- Real god old operating cash flow. This is what I'm hoping will grow at 15% a year and pay dividends in my old age.

Isn't that rather obvious?

It is a truth universally acknowledged that managers manage to optimise that which is measured -- particularly where their own short-term performance-related pay is involved. If I'm a CEO with bonus and option grants tied to Ebitda, and the analysts are valuing my stock on Ebitda multiples, I'll manage around Ebitda. If I'm cynical, I'll throw money at 'assets', at cap ex and R&D -- anything that I can capitalise and charge over the next five to 10 years. And I'll re-classify as much operating expense as possible as cap ex so I can spread it into the future -- like IT expenditure. The accounting standards boards and tax authorities help here: they want me to capitalise my IT spend and pay more tax earlier. …

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