Why EBITDA might not be equal to Cash

Mriya Financial Statement Analysis

EBITDA (Earnings before Interest, Taxes, Depreciation, and Amortization) is used in many cases as a proxy for cash flow. Especially financial investors such as Private Equity firms use the relationship between EBITDA and Enterprise Value (EV) by using EV/EBITDA multiples to value a company. The reason EBITDA is chosen and not EBIT (Earnings before Interest and Taxes) is that depreciation and amortization can be manipulated while cash cannot. Therefore the belief in EBITDA is a solid proxy for cash flow.

In most cases, EBITDA indeed is only very hard to manipulate. However, in many industries such as manufacturing, above the revenues line, there is already a line item called “change in inventory”. This “change in inventory” already depends on the inventory accounting method (FIFO, LIFO, etc.) and thus already leaves some room for manual adjustment.

A more severe manipulation of EBITDA can happen in industries where the income occurs only once a year (e.g. in Agriculture) or once in a lifetime (Forestry). Thus the company will be faced with the problem that first there are only costs while the income will occur later. So without including the income, this will make the company look very unfavorable. Therefore some of the accounting standards such as IAS 41 IFRS 13 were created to account for biological assets by allowing them to be accounted at their estimated fair value basically as income.

From a financial analyst and investor point of view – both are interested in cash flows -, the understanding of EBITDA now becomes critical. Below example of Mriya Agriholding, the largest wheat producer in Ukraine currently in restructuring shows the implication of a fair value estimation of EBITDA very clearly:


Source: Mriya, Management Presentation June 2012

So basically from USD 188m in EBITDA in 2011, USD 157m originates from the fair value of biological assets, meaning the harvest would occur next year, leaving this income at its business risk till the harvest actually can occur. EBITDA had to be estimated by accountants based on fair value calculations and by using their best judgment (which is not the same as actual sales). This basically puts EBITDA up for discretionary use and can reduce the significance of EBITDA as a measure of cash flow quite drastically.

This is just a short reminder that even EBITDA might not be free from manipulation attempts by creative management. For this reason, it’s important to actually understand the real cash flows in more detail and focus the valuation considerations on effective cash in / out. Thus in some industries even EBITDA has to be treated with caution.

See our financial model templates on agriculture which can give you some ideas on how to build financial models for companies focused on agriculture.

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