A crucial red flag when evaluating a new acquisition target is a lack of customer…
EBITDA is Not Cash Flow
|The world has become obsessed with EBITDA. Public companies, private companies, business owners, investment bankers, lenders, valuation firms, and the mainstream business media constantly reference EBITDA and use it as a business term to negotiate value, define agreements, and reference cash flow. However, EBITDA is not cash flow, and frankly, it is far from it. In fact, it is not an accounting term, nor is it recognized under Generally Accepted Accounting Principles (GAAP).Earnings before interest, taxes, depreciation and amortization (“EBITDA”) was created in the 1970’s to demonstrate the cash flow generation potential of the cable television industry, and was also used by leverage buyout firms. Over time, this non-GAAP metric has taken center stage and is widely used to demonstrate a company’s financial health. Unfortunately, this metric ignores real cash expenses that must be paid, such as capital expenditures, taxes, and funding working capital. These cash outlays need to be understood and properly reflected in any cash flow calculation and company valuation.
As a buyer, we do not care about EBITDA. We care about whether a business under our ownership can: (i) reinvest in and expand its capital assets (capital expenditures), (ii) service its debt, (iii) give raises and bonuses to its employees, and (iv) deliver equity returns to its shareholders. The quote below properly summarizes this.
“It amazes me how widespread the use of EBITDA has become. People try to dress up financial statements with it. People who use EBITDA are either trying to con you or they are conning themselves … People want to send me books with EBITDA, and I say fine, as long as you pay the CapEx [and other cash expenditures].” — Warren Buffett