EBITDA's Foggy Bottom Line

Once upon a time, most companies treated revenues, cash flow, and net income as the sacred measures of performance -- the numbers on which investors should focus. Then about a decade ago, media and technology outfits adopted their own performance benchmark -- a variation on cash flow known as EBITDA, or earnings before interest expense, taxes, depreciation, and amortization. Telecoms followed suit, and over the years the industries that embraced EBITDA began to promote it as a more appropriate measure of earnings than net income.

The rationale behind EBITDA was that it reflects what's happening in core operations, while stripping out expenses that are, in theory, extraneous. The accountants who came up with this idea inevitably worked for companies that took on large amounts of debt to fund acquisitions. They argued that taxes vary so much, depending on acquisitions and losses in prior years, as to distort net income. Moreover, they posited that depreciation of assets -- which rises in the wake of frequent mergers -- doesn't involve any real outflow of cash and, therefore, shouldn't be allowed to artificially lower profits.