Be Careful When Using EBITDA for the Terminal Valuation Calculation Reviewed by Momizat on . Be Careful When Using EBITDA for the Terminal Valuation Calculation If youâ€™re going to construct consistent valuations, use earnings instead of cash flows in yo Be Careful When Using EBITDA for the Terminal Valuation Calculation If youâ€™re going to construct consistent valuations, use earnings instead of cash flows in yo Rating:
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# Be Careful When Using EBITDA for the Terminal Valuation Calculation

Be Careful When Using EBITDA for the Terminal Valuation Calculation

If youâ€™re going to construct consistent valuations, use earnings instead of cash flows in your calculations. Why is it important to be consistent? Because you have to calculate a discount rate based on one or the other. Richard Claywell explains.

I was recently asked to review a report prepared by another expert. The other expert calculated an EBITDA and then had a line item titled â€ścash flow adjustment.â€ťÂ  The dollar amount of the cash flow adjustment was zero. The expert did not make adjustments for capital expenditures, changes in working capital, or changes in long-term debt.Â  In fact was, the expert was using earnings instead of cash flows.Â

This poses a serious problems for the valuation expert in that the discount rate was developed using an after tax cash flow rate and this method used a pre-tax earnings rate.Â  There were no adjustments to reconcile these two approaches. The expert actually found some EBITDA multiples and multiplied them by the â€śadjusted cash flowâ€ť calculated value.Â

The EBITDA multiples should be examined.Â  The question is: how are the EBITDA calculations derived and are they comparable to the subject company?Â  The EBITDA is arrived at by considering the assets and cash flows of a company.Â  The buyer and seller will negotiate a price based on the specifics of the sellerâ€™s assets and cash flows to be acquired.Â  This makes the EBITDA an investment value multiple.Â  Investment value multiples should not be used when the standard to be used is Fair Market Value.

J. Richard Claywell, CPA, ABV, CBA, CVA, CM&AA, CFFA, CFD has decades of experience in business valuation, forensic accounting, wealth management, and exit planning strategies.Â  Contact him asÂ richard@biz-valuation.com

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