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Hi Tutor,
Could you please explain this statement to me, EBITDA does not take into account the cash flow relating to working capital or fixed asset replacement.
Thank you.
The E of EBITDA stands for ‘earnings’. Really this meand profit, but profit is not affected by increases or decreases in receivables, payables or inventory. Nor is it affected by the purchase of non-current assets.
So, although EBITDA attempts to relate to cash (eg it is before depreciation) it does not perfectly equate to cask movements because cash can be profoundly affected by working capital changes and capital expenditure.
Hi tutor,
one more question relating to EBITDA,One of the disadvantages written in the book, “It can be easily manipulated by changing the accounting policies relating to income recognition and capitalisation of expense.”
Thank you.
Earnings = income less expenses.
Therefore, if youmchamge how income is recognised you change earnings. For example, if a business has 6 month contracts with customers it could recognise all the earnings as soon as the contract is signed or could spread earnings over the six months. Accounting stamdards try to cut down a company’s ability to pick and choose accounting policies.
Similarly, implememting a different policy on capitalising developmenf expenditure will affect expenses and hence affect earnings.
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