Question

Question:

Many companies publicly describe their performance using terms such as “EBITDA” or “earnings purged of various expenses” because they believe these terms more effectively reflect their companies’ performance than GAAP-defined terms such as net income. What ethical issues might arise from the use of such terms and what challenges does their use present for the governance of the company by stockholers and directors?

Answer 1

ANSWER:

Many of the bankers now-a-days interested in EBITDA as it is the operating cash flow without any non cash expenses like depreciation and amortization but it can be misused also.Not with the bankers but when it is presented to shareholders or general public who are interested in investing in that company it can be manipulating as it was not their actual profit that will be distributed which would raise an ethical issue as the GAAP provides transperacy and by use of EBITDA it protrays as the company that the actual company is not.

Moreover the shareholders and directors cannot concludes the important issues like working capital requirements and real value of assets using EBITDA as the value of assets remains constant as EBITDA ignores amortization and depreciation and working capital requirements cannot be ascertained as by removing depreciation and amortization from EBITDA may result in low profit or even loss.

Calculate EBITDA

There are two formulas for calculating EBITDA. The first formula uses operating income as the starting point, while the second formula uses net income. Both formulas have their benefits and drawbacks. The first formula is below:

EBITDA = Operating Income + Depreciation and Amortization

Operating income is a company's profit after subtracting operating expenses or the costs of running the daily business. Operating income helps investors separate out the earnings for the company's operating performance by excluding interest and taxes.

EBITDA Example

Below is the income statement for JC Penney Company Inc. (JCP) as of May 5, 2018.

• Operating income was $3 million, highlighted in blue.
• Depreciation was $141 million, but the $3 million in operating income includes subtracting the $141 million in depreciation. As a result, depreciation and amortization need to be added back into the operating income number during the EBITDA calculation.
• EBITDA was $144 million for the period or $141 million + $3 million

Read more: What is the formula for calculating EBITDA? | Investopedia https://www.investopedia.com/ask/answers/031815/what-formula-calculating-ebitda.asp#ixzz5OvbQbqRm
Follow us: Investopedia on Facebook