Ebitda: investors’ friend or foe?

Many companies now present an Ebitda (earnings before interest, tax, depreciation and amortisation)

number in their annual and interim reports, usually among the ‘financial highlights’ or in the ‘financial review’ section of the report. Management claim they are merely responding to investor demand for a forward-looking earnings number. Disclosing the figure saves investors the trouble of calculating it themselves.

Financial regulators, however, warn investors to be wary of Ebitda and other so-called pro forma earnings numbers devised by management that are not supported by accounting standards or generally accepted accounting principles. Under SEC rules, companies listed on US stock exchanges must reconcile any ‘pro forma’ earnings number (such as Ebitda) to the US GAAP-based earnings number on the income statement.

Required

(a) Why do you think some investors are interested in Ebitda? What are the advantages of this earnings number over the earnings numbers – such as operating income, income before tax and net income

– reported in the income statement?

(b) Why are financial regulators sceptical about Ebitda? What are the potential flaws of this earnings number as a performance measure?

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