EBITDA vs NOPAT? And why does it matter?

A lot of clients ask about valuation methods and the underlying metric we use to value their business – EBITDA (Earnings Before Interest, Tax, Depreciation and Amortisation) – which is commonly used and often referred to especially around listed companies or NOPAT (Net Operating Profit after Tax).

NOPAT vs EBITDA

I prefer NOPAT and we use it in all our reports and valuations – the key is in the name – Net Operating Profit – Net as in – after everything is included, EBITDA – before as in – excluding a lot of key items.

To calculate the true underlying value of the business, surely we need to do so with everything factored into the calculation?

EBITDA simply excludes too many items – items which are real costs of running the business – depreciation is the accounting method to factor in the very real cost of equipment usage and replacement over time, interest is interest and lenders will insist it is paid, Amortisation is the cost of assets spread over time and of course tax is not really ever going to be excluded – try that argument with the ATO!

Warren Buffett has been an ardent critic of EBITDA. His criticism, in general terms, comes down to three points:

EBITDA does not account for:

• depreciation;
• taxes;
• interest payments;

All of which are very real costs to the company.

Warren Buffett, a well-known financial expert, has expressed his dislike for the EBITDA metric, which is widely used in corporate finance. 

Although it is a useful metric for facilitating comparisons, EBITDA receives significant criticism for neglecting capital expenditures and changes in net working capital, among other issues.

EBITDA is a non-GAAP metric that is affected by management discretion on which items to add back or deduct. While the adjustments are made to portray the core recurring financial performance of the company, the lack of standardization and subjective judgment can lead to “creativity” in how EBITDA is calculated. Therefore, using EBITDA as a standalone profitability metric can be misleading, especially for capital-intensive companies. Buffett believes that EBITDA is not a true representation of a company’s financial performance, especially if management is deemed trustworthy. It is important to be aware of the metric’s shortcomings, despite it being the industry standard for evaluating companies and the most widely used proxy for operating cash flow.

Charlie Munger is even more critical –

“I think that, every time you saw the word EBITDA [earnings], you should substitute the word “bullshit” earnings.”

If you would like some advice on what method is best for the valuation of your business, get in touch with one of our Advisers. To calculate the value of your business before you speak with an adviser, try our simple online Business Valuation tool.

Craig West

Executive Chairman | Succession Plus

Craig West is a strategic accountant with over 20 years of experience advising business owners. His background as a CPA in public practice has provided invaluable experience in the key issues of concern to business owners.

In March 2014, Craig was appointed Executive Chairman of the SME Association of Australia, Australia’s largest small business organisation representing over 300,000 business owners.

In October 2014, he was awarded the Exit Planner of the Year at the Exit Planning Institute Annual Conference in Texas, USA, due to his innovative development of an exit planning process to help business owners maximise business value and achieve a successful exit.

Craig’s proprietary structure - a Peak Performance Trust - has won the Australia-wide award for the Employee Share Ownership Plan of the year twice in four years.

In November 2018, Craig launched SME Experts in partnership with Mark Bouris’ Mentored on Podcast One and quickly grew the monthly podcast audience to over 26,500 downloads; in October 2019, he released a new podcast focused on medium-sized businesses - Mid-Market Matters.

In July 2021, Craig joined the NSW Committee for STEP (Society of Trust & Estate Practitioners) – focusing on advising families across generations.

Craig has also launched a SaaS platform, Capitaliz (which captures the 21-step process), to assist other advisers internationally deliver advisory services at scale.

In November 2021, Craig was appointed Executive Chairman of NSW Leaders, a business mentoring group for leading NSW businesses.

In July 2022, Craig West received the award of Doctor of Business Administration for his research thesis titled “Examination of the key factors driving business exit options in Australian Small and Medium Enterprises.”

Craig is passionate about encouraging business owners to think strategically, maximise the value of their business and achieve a successful exit.