Criticisms of EBITDA
1. Inclusion of Depreciation: Depreciation is considered while calculating earnings before interest and taxes. When comparing data from various sectors, depreciation discrepancies will occur. For example, if a person compares the earnings before interest and taxes of a company with a significant amount of fixed assets to those of a company with few fixed assets, the company with fixed assets will have lower earnings before interest and taxes because the expense reduces net income or profit.
2. Dependance of Debt: Companies that rely heavily on debt incur significant interest expenses. Earnings before interest and taxes do not account for such interest expenses, resulting in an inflating of the company’s earnings potential. Investors may be misled if interest expenditure is not taken into account, as poor sales performance or lower cash flow may have led to the firm taking out large loans. However, EBITDA fails to attract the attention of investors to such significant indebtedness.
3. No Inclusion of Cash Flows: EBITDA does not represent the business’s cash flows. Cash flow details are an important sign of whether a firm can pay its short- and long-term financial obligations, which will determine its future growth chances.
4. No Tax Planning: This strategy is ineffective for tax planning since it does not take into consideration the tax due, which is critical when making financial decisions.
5. Easily Manipulated: The procedure is prone to data manipulation and deception in order to create a lucrative picture of the firm. It distorts accounting processes, such as spending capitalization and revenue recognition standards, which are commonly used in businesses. As a result, prior to implementation, it is critical to thoroughly review the books of accounts.