EBIT or EBITDA: what is the Court telling us

In a recent NSWSC judgment, this issue was explored by the Court with Black J confirming a common long-standing belief that EBITDA is preferred where irregular depreciation materially effects the valuation conclusion.

EBIT and EBITDA are two of the most common metrics applied by business valuers as a proxy for the future maintainable earnings of a business, with the difference between the two metrics being ‘Depreciation’ and Amortisation’.

• EBIT: an abbreviation for Earnings Before Interest and Taxation, being the total revenue of the entity less the total expenses, with the exception of interest and taxation.
• EBITDA: an abbreviation for Earnings Before Interest, Taxation, Depreciation and Amortisation, being the total revenue of the entity less the total expenses, with the exception of interest, taxation, depreciation and amortisation. 

The matter of Munja Bakehouse Pty Ltd [2024] NSWSC 6 involved a shareholder oppression dispute regarding a wholesale bakery which manufactured and distributed gluten free bakery goods.

The Plaintiffs and the Defendants both sought, essentially, the same relief, namely that the other party purchase the shares in Munja and Smith Street [the property owner] as their first preference, and a winding up order as their second preference.

The Defendants relied on a detailed expert report of Mr G and the Plaintiffs relied upon a report of Mr S. Mr G valued the shares in Munja alternatively on an EBITDA and EBIT basis.

Baker J stated that:

“It emerged in Mr G’s cross-examination that his valuation on an EBIT basis was likely distorted by the fact that Munja had made use of accelerated depreciation opportunities made available during the COVID-19 period, which would not ordinarily be available, so that its earnings after depreciation in that period would not be indicative of the earnings that it could ordinarily achieve. …” [67 ]

Counsel for the Defendants argued two main points in support of the use of EBIT:

1. EBIT was at least an additional means of assessing the value of the properties, including the materiality and importance of depreciation to the activities of the business.
2. the fact that the financial reports and taxation returns of Munja were prepared with the assistance of a third-party accountant.

Counsel for the Plaintiffs argued if an EBIT approach were adopted, it would be necessary to correct the EBIT at least in the FY23 year and determine a normalised EBIT and then further to correct Mr G’s EBIT range, because of the effect of accelerated depreciation adopted by Munja in FY23.

In summarising his findings, Black J stated that:

“… that an EBITDA valuation has the advantage, in principle, that it removes factors which can be affected by business owners’ decisions as to depreciation methods, financing structures and tax, so as to demonstrate the underlying earnings of the business, excluding the effect of its capital structure, and to that extent provides a better measure of a company’s operating performance. That approach is consistent with [other] evidence that an EBITDA valuation is ordinarily used in commercial transactions involving the sale and purchase of a business. Here, I would prefer Mr G’s EBITDA valuation of those shares to his EBIT valuation because it avoids the distortion for depreciation that would otherwise arise.” [70]

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