The EBITDA multiple resulting from these formulas offers a simple estimate of the firm's value in terms of EBITDA.
There are several reasons why analysts like to use EBITDA multiples.
Over the years, the use of EBITDA multiples has garnered wide support.
This future period, shown as t + [tau] in the equation above, is spanned by discounting the resulting normal EBITDA value to the present using the firms discount rate and then multiplying by the industry EV/EBITDA multiple attained from a comparable list of firms.
Although this EBITDA methodology appears simple, analysts must be aware of its limitations.
In order to get a more accurate interpretation of the value of a firm using the EBITDA multiple, an analyst should be aware that there are many ways to manipulate the numbers.
Percentage-of-completion accounting is another example where EBITDA fails to portray accurate cash flows.
Financial analysts use EBITDA in a number of applications such as measuring the financial performance of a company, calculating simple valuations of a firm, and as a measure of a firm's cash flows.
Many analysts use EBITDA as an approximation of cash flows, and sometimes even as a Free Cash Flow calculation, but EBITDA is not a substitution for the proper calculation of FCF, as it makes no allowance for cash flows to working capital or capital expenditures needed for continuing operations (Eastman, 1997; Fridson, 1998).
Another popular use of EBITDA is in aiding in the determination of the ability of a company to adequately service its debt and EBITDA is often thought to be a better measure of debt service capabilities than the other traditional interest coverage ratios.