“Whenever you see EBITDA, you should replace it with ‘nonsense earnings.’” — Charlie Munger
This quote from Warren Buffett’s long-time partner perfectly captures the problem with EBITDA-based company valuations.
The Problems with EBITDA
EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization) has several critical flaws:
Depreciation is Ignored
Assets wear out and need replacement. Ignoring depreciation pretends that equipment, vehicles, and other assets last forever—they don’t.
Taxes are Unavoidable
No matter how creative your accounting, taxes are a real expense that affects cash flow.
Debt Costs Money
Interest payments are real cash outflows. Ignoring them paints an unrealistic picture of profitability.
Equipment Replacement
Eventually, you’ll need to replace worn-out equipment. EBITDA ignores this inevitability.
The Problem with “Adjusted EBITDA”
Even worse is “Adjusted EBITDA,” which removes “one-time” expenses. The problem? There’s always a one-time expense. This metric can easily be manipulated to show whatever number the seller wants.
A Practical Valuation Formula
Here’s a more grounded approach to company valuation:
The Formula
- Net Profit Before Tax × 2.5-3.5 multiplier
- Plus: Net Assets
- Minus: Liabilities
- Plus: Cash on Hand
Multiplier Factors
The multiplier you use (2.5 to 3.5) depends on:
- Management Quality – Can the business run without the owner?
- Customer Diversity – Is revenue concentrated in a few customers?
- Predictable Revenue – Are there recurring revenue streams?
- Growth Potential – Is the market expanding?
- Industry Trends – Is the industry growing or declining?
Example Calculation
Let’s value a company with:
- Net Profit Before Tax: €850,000
- Net Assets: €50,000
- Liabilities: €200,000
- Cash on Hand: €100,000
Calculation:
- €850,000 × 2.5 = €2,125,000
-
- €50,000 (Net Assets)
- − €200,000 (Liabilities)
-
- €100,000 (Cash)
- = €2,075,000
The Bottom Line
Remember this mantra:
“Revenue is vanity, Adjusted EBITDA is fantasy, Net Profit Before Tax is reality.”
When evaluating a business—whether to buy or invest—focus on the actual cash the business generates, not accounting metrics designed to make things look better than they are.