Complete 2025 Guide to Business Valuations: Is EBITDA Flawed?

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Whether you’re an institutional investor or financial advisor, mastering business valuation is the key to making informed acquisition and investment decisions. Accurate valuations enable you to evaluate opportunities with confidence.

While there are many ways to evaluate a company’s financial health, Earnings Before Interest, Taxes, Depreciation, and Amortization (EBITDA) is a popular method. Many analysts appreciate it for its simplicity, though critics warn that it can distort the picture of a company’s true profitability and cash-generating capacity.

So, is EBITDA a flawed metric? And are there better valuation alternatives? Below, we’ll break down EBITDA, explain how it’s calculated, and outline its pros and cons. We’ll also explore some alternative methods that can offer a more complete picture of a business’ value.

What is Earnings Before Interest, Taxes, Depreciation, and Amortization (EBITDA)?

EBITDA is a financial metric that measures a company’s core operating profitability. It takes a company’s net income and adds back its interest, taxes, depreciation, and amortization. By doing so, EBITDA isolates the company’s operating performance from the effects of its financing decisions, tax strategies, and non-cash accounting entries.

Here’s a brief overview of the items EBITDA excludes:

Interest – The cost of debt, including loans, bonds, and other financing obligations. Excluding interest allows you to analyze companies’ performance independent of their capital structure.
Taxes – Government levies on a company’s earnings, such as income or corporate taxes, which can vary widely by jurisdiction and corporate strategy.
Depreciation – The systematic allocation of the cost of tangible assets (machinery, equipment, buildings, etc.) over their useful lives.
Amortization – The gradual write-off of intangible assets (patents, trademarks, goodwill, etc.) over time.

By excluding these factors, EBITDA offers a clear view of a company’s operational efficiency, allowing investors to compare performance across industries and capital structures without being influenced by temporary, discretionary, or varying accounting choices.

How to Calculate EBITDA

To calculate EBITDA, simply take a company’s net income and add back its interest expenses, taxes, depreciation, and amortization. For example, a company with $5 million in net income, $1 million in interest, $2 million in taxes, $500,000 in depreciation, and $500,000 in amortization would have an EBITDA of $9 million.

Many analysts also use Adjusted EBITDA, which incorporates additional add-backs for one-time or non-recurring expenses, such as restructuring costs, legal settlements, or non-operational losses.

Since EBITDA is a non-GAAP financial metric, it doesn’t adhere to Generally Accepted Accounting Principles. Thus, the specific way that companies compute it can vary considerably.

When Did EBITDA Become Popular?

EBITDA first gained popularity in the 1980s, thanks to media mogul John Malone. He built his fortune by acquiring and restructuring heavily leveraged cable companies. However, he faced a notable problem: many of these operators carried large debt loads, pushing their net income into negative territory, even though their core operations were generating strong cash flows.

By focusing on EBITDA, Malone was able to highlight the true operational profitability of these businesses, stripping out any distortions caused by debt, tax strategies, and non-cash accounting expenses. This approach made it easier for his investors to assess whether these companies were fundamentally healthy, even when their reported net income looked poor on paper.

Today, EBITDA remains a widely used metric for mergers and acquisitions, corporate financing decisions, and internal performance benchmarking. Private companies, especially those preparing for a sale or seeking external investment, may emphasize their EBITDA in financial presentations.

What Are the Benefits of Using EBITDA?

EBITDA remains a popular valuation metric for several reasons. When used appropriately, it offers the following advantages:

Focus on operational profitability – By removing financing, tax, and non-cash accounting details, EBITDA provides a clear measure of a company’s operational profitability.
Convenient comparisons – EBITDA enables apples-to-apples comparisons across companies within the same industry. Thus, it allows you to evaluate businesses with similar operations but different debt levels or depreciation schedules on a more level playing field.
Useful screening tool – EBITDA can provide a fast, high-level view of a company’s operational performance, making it an effective preliminary screening tool for investments or acquisitions. You can use it to quickly identify promising targets and focus your deeper financial analysis where it matters most.
Effective communication – EBITDA’s simplicity makes it an effective communication tool. Investors, boards, and management teams can use EBITDA to convey companies’ operational performance in a way that’s easy to understand, especially during preliminary discussions.

EBITDA Criticisms

Despite its many benefits, EBITDA has also faced significant criticism. Legendary investor Warren Buffett and Berkshire Hathaway Vice Chairman Charlie Munger are two outspoken skeptics. Here are some of their pointed critiques:

Warren Buffett – In a 2000 Berkshire Hathaway annual report, Buffett said, “References to EBITDA make us shudder – does management think the tooth fairy pays for capital expenditures?” He reiterated his criticism two years later at Berkshire Hathaway’s 2002 annual shareholders meeting, remarking, “It amazes me how widespread the use of EBITDA has become. People try to dress up financial statements with it.”
Charlie Munger – Munger famously remarked, “Every time you see the word EBITDA, you should substitute the word ‘bullshit’ earnings’.” He restated his skepticism during the 2017 Berkshire Hathaway annual meeting, adding, “And now they use it in the business schools. That is horror squared. It’s bad enough that a bunch of thieves start using a term, but when it gets so common that the business schools copy it, that’s not a good result.”

What are EBITDA’s Limitations?

So, why do Buffett and Munger have such harsh words regarding EBITDA? Their distaste is due to the following reasons:

EBITDA ignores cash flow obligations – EBITDA excludes several costs that are critical to a company’s day-to-day operations. Thus, a business with strong EBITDA may still struggle to pay off its loans, cover supplier invoices, and manage payroll behind the scenes. If you only look at EBITDA, you may not see signs that the company is struggling with liquidity and long-term viability.
EBITDA overlooks capital expenditures – Depreciation and amortization represent real costs of maintaining and replacing assets over time. Since EBITDA ignores these costs, it can make companies appear more profitable than they really are. If you base your investment decisions on EBITDA alone, you may underestimate the funds required to sustain a company’s growth or replace its worn-out assets.
EBITDA leaves room for manipulation – Since EBITDA is a non-GAAP metric, companies can get creative in their calculations. For instance, some companies may aggressively re-classify recurring or essential costs as “one-time” expenses to boost their Adjusted EBITDA. Meanwhile, others may accelerate their revenue recognition or delay their expense recording to temporarily boost their EBITDA during key reporting periods.
EBITDA lacks standardization – EBITDA’s lack of GAAP oversight means that there’s no universally accepted formula for how it’s calculated. Companies may apply different adjustments based on internal preferences or industry norms. Inconsistencies regarding depreciation, amortization, or one-time items can distort EBITDA, reducing its usefulness for comparing companies.

With these limitations in mind, EBITDA can still be an insightful starting point, but it shouldn’t be used in isolation. Instead, you should pair it with other business valuation approaches to gain a more holistic view of a company’s true financial health and long-term sustainability.

EBITDA Manipulation: A Real-World Example

To clarify how EBITDA can be misused, let’s take a look at a real-world example. WorldCom, a massive telecommunications company, collapsed in 2002 due to a historic accounting scandal.

Between 2001 and the first quarter of 2002, WorldCom shifted billions of dollars in operating expenses—primarily “line costs” paid to other telecom providers—into capital accounts. According to GAAP, these expenses should have been recorded immediately on the income statement.

By capitalizing them instead, WorldCom artificially reduced its reported expenses and exaggerated its EBITDA, creating an inflated picture of operational profitability. This led the company to report an EBITDA of $2.393 billion in 2001, despite actually incurring a net loss of $662 million. This misled investors to believe the company was highly profitable, propping up its stock price until the scandal was revealed.

This example highlights how EBITDA can be a useful shorthand for operational performance, but it can also be weaponized to mislead investors and other analysts. That’s why investors and advisors should always cross-reference EBITDA with GAAP-based net income and cash flow statements.

Alternative Approaches to EBITDA

Since EBITDA has serious limitations, you may be wondering which business valuation methods you should use instead. Here are four alternatives that offer a more accurate picture of a company’s value:

#1 Free Cash Flow

Free Cash Flow (FCF) measures the actual cash a business generates from its core operations after accounting for capital expenditures. Unlike EBITDA, which excludes key expenses, FCF captures the real liquidity available to reinvest in growth, repay debt, or return capital to shareholders.

FCF is especially valuable because it reflects a company’s ability to sustain operations and growth without relying on external financing. A business with strong EBITDA but weak or negative FCF may appear profitable on paper but face serious liquidity constraints in practice.

#2 Net Income and Earnings Before Interest and Taxes

Net Income and Earnings Before Interest and Taxes (EBIT) are two metrics that offer a more complete view of a company’s financial performance than EBITDA:

Net income represents a company’s bottom-line profit after subtracting all of its expenses, including interest, taxes, depreciation, and amortization. It reflects the actual earnings available to shareholders and serves as a cornerstone for valuation metrics such as the price-to-earnings (P/E) ratio.
Meanwhile, EBIT isolates a company’s operating performance by excluding non-operational factors, including its interest expenses and tax strategy. Unlike EBITDA, it includes depreciation and amortization, giving analysts a clearer picture of how the company’s core operations perform after accounting for wear and tear on assets.

These metrics ground business valuations in real-time reality, making them harder to manipulate and more reflective of a company’s true profitability.

#3 Revenue Multiples

Revenue-based valuation methods, such as Enterprise Value to Revenue (EV/Revenue), are often used when earnings-based metrics are unreliable. They’re especially useful for early-stage, high-growth, or distressed companies with inconsistent or negative earnings.

Revenue is also less susceptible to accounting distortions, so this approach offers a consistent, scalable framework for comparing companies across industries or growth stages. But since revenue doesn’t reflect profitability or cash flow on its own, this method should be paired with others to avoid overvaluation.

#4 Multi-Method Valuation

Rather than relying on a single metric, sophisticated investors and financial analysts often use a multi-method approach, combining several valuation strategies to cross-check results, including:

EBITDA and revenue multiples
Discounted cash flow (DCF)
Comparable company and precedent transaction analyses
Asset-based valuations

By blending these methods, you minimize the risk of skewed results from any one approach, even amid market fluctuations or economic uncertainty.

Is EBITDA Flawed? A Final Verdict

To sum it up, EBITDA can be a useful metric for preliminary business valuations. Its ability to isolate operational performance and simplify comparisons across companies makes it a practical tool for initial screening, benchmarking, and early discussions with management.

However, due to its notable drawbacks and susceptibility to manipulation, EBITDA should never be used in isolation. Combining it with complementary valuation methods provides a more complete and reliable picture of a company’s performance, value, and risk profile.

Leverage Alden Investment Group’s Business Valuation Expertise

Understanding EBITDA and its limitations is only one part of making effective investment decisions. At Alden Investment Group, we help institutions go beyond surface-level metrics by delivering advanced analytics and hands-on support.

Our institutional advisory services include:

Comprehensive valuation guidance – We help interpret and reconcile EBITDA with cash flow dynamics, capital structure, and sector-specific benchmarks. Our team integrates FCF analysis, operating income, revenue multiples, and multi-method valuation frameworks to build a nuanced view of enterprises’ value.
Portfolio & transaction analysis – Whether evaluating acquisition targets, private market investments, or internal portfolio holdings, we deliver institutional-grade diligence to support confident decision-making.
M&A strategy and deal structuring – Thanks to our deep investment banking roots, we know how to support institutions and advisors through the full M&A cycle, from initial valuation and strategic alignment to deal execution and post-transaction integration.
Customized reporting and communication – At Alden Investment Group, we provide digestible, decision-ready insights that clarify the assumptions behind adjusted EBITDA, valuation multiples, and projected returns, ensuring all stakeholders are aligned and informed.

By partnering with us, you can gain clarity, context, and actionable insights about your portfolio and M&A options. To learn more about our capital markets services, contact Alden Investment Group today!

Sources:

Investopedia. Generally Accepted Accounting Principles (GAAP): Definition and Rules.
https://www.investopedia.com/terms/g/gaap.asp

Professional Leadership Institute. EBITDA.
https://professionalleadershipinstitute.com/resources/ebitda/

Warren Buffett Archive. 2002 Annual Meeting.
https://buffett.cnbc.com/2002-berkshire-hathaway-annual-meeting/

Forbes. EBITDA Is ‘BS’ Earnings.
https://www.forbes.com/sites/brentbeshore/2014/11/13/ebitda-is-bs-earnings/

Yahoo! Finance. Charlie Munger explains why he called a popular earnings measure ‘horror squared.’
https://finance.yahoo.com/news/charlie-munger-explains-called-popular-earnings-measure-horror-squared-164228068.html

SEC. Complaint: SEC v. Worldcom, Inc.
https://www.sec.gov/litigation/complaints/complr17588.htm