Question

Discuss differences between the following pros and cons of each to measure profit. It can be brief

d. EBITDA

e. Adjusted EBITDA

f. Cash from Operations

g. Free Cash Flow

Answer 1

(d): EBITDA – This is earnings before interest, taxes, depreciation and amortization. The pros of using EBITDA as a profit measure is that it provides a better view of actual business health, it takes into consideration only the necessary expenses that are incurred towards day to day running of the business and it represents cash flow that is generated by the ongoing operations of a business. In terms of cons this measure of profitability does not consider changes in liquidity due to interests, taxes and capital expenditures.

(e): Adjusted EBITDA – This measure removes one-time, irregular and non-recurring items from EBITDA. The pro of using adjusted EBITDA is that the profit measure is normalized and is not distorted by irregular gains and losses. In terms of cons adjusted EBITDA is easy to manipulate and can make room for fraudulent accounting techniques.

(f): Cash from operations – The pros of using cash from operations are that the focus is on the revenue generating activities of a business. It shows how much money a company can bring in through its ongoing regular business activities. In terms of cons this measure of profit excludes long term capital expenses and investment costs and hence will be biased against long term investments and projects.

(g): Free cash flow – Free cash flow is calculated by deducting capital expenditure from the operating cash flow. In terms of pros free cash flow is a trustworthy measurement of profitability and is also useful in determining the intrinsic value of a company’s stock. In terms of cons free cash flow, as a measure of profitability, will unfavorably view growing companies. Companies that are growing will have large amounts of capital expenditures and hence their free cash flow will be negative in the initial phases. This is not necessarily a bad thing as the company is laying base and foundation for future.