EBITDA vs 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).

NOPAT vs EBITDA

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:

• depreciation;
• taxes;
• interest payments;

All of which are very real costs to the company.

Warren Buffett, a well-known financial expert, has expressed his dislike for the EBITDA metric, which is widely used in corporate finance. 

Although it is a useful metric for facilitating comparisons, EBITDA receives significant criticism for neglecting capital expenditures and changes in net working capital, among other issues.

EBITDA is a non-GAAP metric that is affected by management discretion on which items to add back or deduct. While the adjustments are made to portray the core recurring financial performance of the company, the lack of standardization and subjective judgment can lead to “creativity” in how EBITDA is calculated. Therefore, using EBITDA as a standalone profitability metric can be misleading, especially for capital-intensive companies. Buffett believes that EBITDA is not a true representation of a company’s financial performance, especially if management is deemed trustworthy. It is important to be aware of the metric’s shortcomings, despite it being the industry standard for evaluating companies and the most widely used proxy for operating cash flow.

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.

Dr Craig West

Founder & Chairman | Succession Plus

Dr Craig West is a strategic accountant who has over 20 years of experience advising business owners.

With a background as an accountant in practice and two master’s degrees, Craig formed a strong view that the majority of business owners (and often their advisers) were unprepared and unaware of the steps required to prepare for exit. He then designed and documented a unique 21-Step Business Succession and Exit Planning process to assist owners and their advisers in navigating this process.

Craig now acts as a strategic business and financial mentor for mid-market business owners. Craig has written four critically acclaimed books educating business owners on employee incentives, succession planning, asset protection, and exit strategies. Additionally, he has completed doctoral research on Employee Share Ownership Plans (ESOPs) for succession.

Craig is a Member of the Forbes Business Council where he leverages his extensive experience to contribute valuable insights on helping business leaders navigate the complexities of growing and exiting their businesses.

In April 2024, the Exit Planning Institute admitted Craig to the International Exit Planning Circle of Excellence.