In wiley there is a comment regarding the use of EV/EBITDA approach to valuation that " EBITDA overestimates cash flow from operations if working capital is growing." Could anyone understand this sentence? I did not understand the relation.
When working capital is growing, there is a negative CFO associated with that growth; EBITDA doesn’t capture that negative CFO.
thank you, s2000magician, so helpful…
You’re quite welcome.
BTW, this is under Equity Topic Test #4 (Metev). Just bumping this because I thought this was a tricky question. If we used the Indirect Method we would capture the changes in WC.
Why would we ever just stop @ EBITDA and use it as a CF proxy? Maybe I missed it in the curriculum.
See p. 334 Blue Box 17 in the CFAI Equity Book. It covers this via a job interview question.
Anecdote: I used to work for a company that got acquired by a publicly traded firm. Our new parent company reported an “Adjusted EBITDA” figure in their SEC filings. The first quarter ater the acquistion we needed to provide our Parent this “Adjusted EBITDA” figure for our operations. For our company (the sub) this supposed metric made no sense whatsever. I explained why, but they still ‘needed’ to report it. Fortunately, we weren’t that big so it didn’t matter that much to the consolidated figures. For our parent company, it was a dubious metric, and for us it was downright non-sensical.