EBITDA or NOPAT? And why does it matter?
A lot of clients ask about valuation methods and the underlying metric we use to value their business – EBITDA (Earnings Before Interest, Tax, Depreciation and Amortisation) – which is commonly used and often referred to especially around listed companies or NOPAT (Net Operating Profit after Tax).
I prefer NOPAT and we use it in all our reports and valuations – the key is in the name – Net Operating Profit – Net as in – after everything is included, EBITDA – before as in – excluding a lot of key items.
To calculate the true underlying value of the business, surely we need to do so with everything factored into the calculation?
EBITDA simply excludes too many items – items which are real costs of running the business – depreciation is the accounting method to factor in the very real cost of equipment usage and replacement over time, interest is interest and lenders will insist it is paid, Amortisation is the cost of assets spread over time and of course tax is not really ever going to be excluded – try that argument with the ATO!
Warren Buffett has been an ardent critic of EBITDA. His criticism, in general terms, comes down to three points:
EBITDA does not account for:
- interest payments;
All of which are very real costs to the company.
Buffett – on using EBIT or EBITDA as a valuation metric –
“This is nonsense. It couldn’t be worse. But a whole generation of investors have been taught this. ‘It’s not a non-cash expense’ — it’s a cash expense but you spend it first. It’s a delayed recording of a cash expense. We at Berkshire are going to spend more this year on cap ex than we depreciate.”
Charlie Munger is even more critical –
“I think that, every time you saw the word EBITDA [earnings], you should substitute the word “bullshit” earnings.”
If you would like some advice on what method is best for the valuation of your business, get in touch with one of our Advisers. To calculate the value of your business before you speak with an adviser, try our simple online Business Valuation tool.
Looking to sell your business?
Download our guide on 15 tips for maximising business value.