The Accounting Trick That's Killing WorldCom [EBITDA]

One could make a theoretical argument that some advertising costs result in future benefits and should be capitalized. One could also make the same argument for research and development (R&D) costs. However, advertising and R&D costs are required by standards to be expenses as incurred. I do not know the exact nature of the costs that WorldCom capitalized. They are said to be line costs but that does not tell me enough information. Now, they are saying that these costs should have been expensed.

The press is calling it a fraud. Possibly, it could be, but not all disagreements about whether a cost should be capialized or expensed are indicative of fraud. The issue is not always that clear.

EBITDA is not a number reported on the income statement. The income statement would show income before interest and taxes, then the interest expense and then the taxes. Reporting earnings before interest and taxes (EBIT) allows comparisons among companies with different capital structures. However, depreciation and amortization are reported as operating expenses. The statement of cash flows shows cash flows from operations. EBITDA is often viewed as a proxy for operating cash flows.

Corporate boards of directors need to take a stronger oversight role of their companies. However, I oppose more government regulations.

You want to base your investments on numbers produced through accounting chicanery (the article in post #1 on this thread is quite informative on that issue), be my guest.

Before you start mouthing off, I suggest you take a class in accounting and financial statement analysis. Whether or not EBITDA is "chicanery" or not, just like any other accounting number, depends on the honesty of a firm's CFO and its auditor. All it is are sales, less cost of goods sold, less overhead, plus depreciation and amortization. These are all componets of net income, so if EBITDA is "chicanery" so is net income. On the other hand, if net income is soundly calculated, so will EBITDA. No financial figure is immune from dishonest accounting.

But companies should not be allowed to publicly BRAG about it as if it's anywhere near a legitimate statement as to their true financial condition. It makes suckers out of the little people who don't know anything but whatever the CEO is parroting on Squawk Box.

If the little people are dumb enough to believe EBITDA is a complete statement of a company's financial condition, then there's no hope for them whatsoever.

EBITDA is a useful number for measuring the performance of a firm's assets independently of its capital structure, and hence it is very useful in comparing two companies in the same business with different capital structures. If a firm has a higher EBITDA margin than another comparable one (after you take into account extraordinary items), it usually means that it is managing its assets more efficiently.

If you knew anything about finance, you would know that comparing the net income of a highly levered firm with the net income of one with little debt would tell you very little about the relative performance of either one.

Now of course debt and capital structure issues in general are important, which is why anyone who relies upon EBITDA alone is an idiot, since EBTIDA ignores these issues. But just because EBITDA does not give you a COMPLETE picture of a firm's performance does not mean it is a bad number. There does not exist a single accounting figure or ratio that tells you EVERYTHING.

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