I had a conversation last week with a business owner who had just received an informal valuation from his accountant. Simple calculation: EBITDA times industry multiple equals business value. He rang me, rather pleased with himself, expecting I would confirm the figure, and we could move straight to marketing his business.

We could not.

Having spent years as an accountant myself before specialising in business valuation, I understand the appeal of the formula. It is clean, defensible to clients, and appears authoritative on paper. But it ignores the economic reality underneath. This particular business was generating impressive EBITDA, certainly. But the owner was not paying himself a wage; the business was also deferring capital expenditure, stretching working capital to concerning levels, and carrying debt that consumed most of the supposedly available cash flow. The actual value, the price a rational buyer would pay, was considerably less than the figure on his accountant’s spreadsheet.

This happens frequently enough that it warrants examination. EBITDA has become the shorthand metric for business value, particularly amongst advisers who favour speed over substance. Yet in valuation work conducted in accordance with International Valuation Standards, we cannot simply ignore what EBITDA conceals whilst highlighting what it reveals.

What EBITDA Actually Tells You

EBITDA: Earnings Before Interest, Taxes, Depreciation, and Amortisation, strips away financing costs and accounting treatments to show operational profitability. This serves a purpose. When comparing businesses with different capital structures or tax positions, EBITDA provides useful common ground. One business financed entirely through equity and another carrying substantial debt can be compared on operational merit rather than financing choice.

Fair enough. The problem emerges when EBITDA becomes the destination rather than the starting point. Warren Buffett once remarked that references to EBITDA make him shudder, noting his suspicion of accounting methodology that obscures rather than illuminates. He was not being difficult. He was being accurate.

The Elements EBITDA Ignores

Consider what happens in the real world when businesses operate. They consume capital. Machinery wears out and requires replacement. Technology becomes obsolete. Vehicles need updating. Growing businesses require ever increasing levels of working capital to fund things like growth in wages and inventory, extending credit to customers, and managing supplier relationships. Businesses carrying debt must service that debt regardless of what their EBITDA suggests about profitability.

These are not theoretical concerns. They represent cash, actual cash that flows out of the business and must be accounted for in any genuine assessment of value. EBITDA, by its very construction, ignores all these facts.

Take capital expenditure. Depreciation represents the gradual decline in value of assets that will eventually require real money to replace. A business deferring essential capital expenditure whilst showing strong EBITDA is not performing as well as the numbers suggest. The bill must eventually come due, and when it does, operational capacity reveals itself accurately. This becomes particularly acute in capital-intensive sectors: manufacturing, logistics, and construction, where ongoing investment represents a fundamental cost of competitiveness.

Additionally, accurate accounting treatment of asset purchases (including the depreciation journals) has virtually disappeared in the books of SME’s for many reasons… changing tax regulations, poor bookkeeping skills, time-poor external accountants who historically “fixed” the books at least annually but have long ago ceased to do those reconciliations.

Working capital operates similarly. A business growing rapidly typically needs to focus on increasing its working capital to fund that growth trend. As you take on more projects, you carry more stock, extend more credit, have a larger payroll and manage larger payables. This consumes cash that never appears in your EBITDA calculation but remains absolutely essential to operational capacity. I have watched business owners present impressive EBITDA figures only to discover during due diligence that their working capital position is dangerously stretched. The acquirer either discounts the price substantially or walks away entirely.

Debt service cannot be wished away by accounting convention. A business showing strong EBITDA but carrying heavy debt loads will have limited cash available for distribution to owners after meeting interest and principal obligations. When family lawyers value businesses for property settlements, or when accountants advise on succession planning, this distinction becomes critical. The business that appears highly profitable on an EBITDA basis may generate rather modest free cash flow once all obligations are met.

Reasonable Wages?

Consider now three wage scenarios. The owner who takes no wages; The owner who pays minimal wages but takes a dividend; The owner who shares his wages with the significant other?

None of these are wrong or illegal; however, all three scenarios skew wages and superannuation expenses, distorting the true operating EBITDA. 

This is just one expense line… think for a moment on all the others which might individually be insignificant. When added up, these can, and usually are, very significant. 

What Buyers Actually Buy

Business value ultimately derives from free cash flow, the cash generated after meeting all operational expenses, and this includes reasonable expenses like wages, capital expenditure requirements, working capital needs, and debt obligations. This is the cash available to business owners. This is what buyers are actually buying.

EBITDA can approximate free cash flow in businesses with low capital intensity, stable working capital requirements, accurate accounting practices and minimal debt. But for businesses outside these parameters, the EBITDA number produces an operational surplus that ranges from unrealistically optimistic to dangerously misleading.

At this point, I have not even touched upon the inherent dangers of guessed industry multiples – but I and many others have written extensively about the flaws inherent in having blind faith in multiples. So we shall save that for another day

My point is – the valuation work we perform examines the P&L and Balance Sheet line by line; we know “where the bodies are buried”, and inaccurate accounts stick out like beacons. That is exactly why we get engaged,d because unfortunately our starting point is that the published annual financial accounts – which are produced for the sole purpose of minimising tax obligations – are simply too inaccurate for the job we have been asked to do.

We will look for capital expenditure patterns and trends over multiple years. We will analyse working capital trends to identify operational efficiency and cash consumption. We assess debt service capacity to determine actual distributable cash flow. We consider growth trajectories and the expenses, like wages, that impact those trends. We adjust, normalise, add and remove until we are satisfied with what we observe. This work is not simply a money-making exercise. This is the difference between professionals who can provide accurate valuations and expensive disappointment.

The Practical Reality

For business owners, understanding these inherent EBITDA limitations creates opportunity. If your business has low capital requirements, efficient working capital management, and minimal debt, you can demonstrate to acquirers that your EBITDA does approximate free cash flow. This justifies premium valuations. Conversely, if your requirements are substantial, present this context proactively rather than have it discovered during due diligence, where it will be used to negotiate down your price with considerable vigour.

For professionals advising business owners, explaining these distinctions is essential. Responding with an EBITDA multiple without examining underlying cash flow dynamics provides false precision and creates expectations that may not survive proper scrutiny.

If you are contemplating your business value, preparing for sale, or require valuation for legal or succession purposes, talk to someone who understands that valuation is more than multiplication. Pick up the phone. Call me directly on 1300 551 757. Let us have a confidential conversation about your business, its cash flow dynamics, and what proper valuation reveals. No obligation. Just honest advice from someone who has conducted valuations across multiple industries and understands the difference between impressive EBITDA figures and genuine business value.