Capharnaum wrote: bandit69 wrote: "Trumpeting EBITDA (earnings before interest, taxes, depreciation and amortization) is a particularly pernicious practice. Doing so implies that depreciation is not truly an expense, given that it is a “non-cash” charge. That’s nonsense. In truth, depreciation is a particularly unattractive expense because the cash outlay it represents is paid up front, before the asset acquired has delivered any benefits to the business. Imagine, if you will, that at the beginning of this year a company paid all of its employees for the next ten years of their service (in the way they would lay out cash for a fixed asset to be useful for ten years). In the following nine years, compensation would be a “non-cash” expense – a reduction of a prepaid compensation asset established this year. Would anyone care to argue that the recording of the expense in years two through ten would be simply a bookkeeping formality?"
Somehow I don't think anyone would listen to what he has to say though. The human ego is too powerful.
As I've mentionned in my previous response to this, it depends on whether the amortized charge is a reflection of the usage of the asset. In the above example, it clearly is, as it is a pre-payment (and the employees would be pre-paid expenses, not assets, btw). At the end of the amortization, the value of the asset should be zero, if that is true.
However, it isn't always the case. If you purchase the name of a brand, then you can classify it as an asset and then amortize it. However, the brand may not lose its value over time. When you purchase another company, the value of the purchase, to you, might be higher than the book value. In that case, you would classify the extra paid over book value as an asset and then amortize it through time. At the end of the amortization period, the company you bought could very well be worth more than what you initially paid for it. In both cases, the "amortization" charge is nothing. The same process goes on for developping software. Yet, the value of the platform usually is durable through time, where you keep on generating cashflows.
That is why, when you evaluate the future value of an asset, you need to look at the cashflows it generates, going forward, and not the earnings. Take the above example you provided (even if employees can't be classified as assets and be amortized over time)... Let's say the company paid from cash on hand in year 1 for the full ten years of service, and you were looking to buy that company in year 2, you'd have to pay the earnings value + the nine years of prepaid salaries (that you'll benefit from but won't have to pay) which would roughly be akin to paying for EBITDA value. Which is why future cashflows discounted by future capex expenses and extra maintenance cost is better/simpler way to derive the value of a stock than earnings. Otherwise you have to adjust earnings for charges that have been paid for you in the past but that you'll still benefit from.