My new hero.
Of the many things I like in it those that I like the most;
1. He's essentially shorting America by investing in its vices. Spend money you don't have, sex, live for the moment. He'll be the one with the cash after it's all said and done.
2. He finds it easier to deal with the Chinese government than the US government.
3. His quip on EBITDA. EBITDA, for those of you without the benefit of an accounting degree is your "Earnings Before Interest, Taxes, Depreciation and Amortization."
This measure is basically the most liberal and handicapped measure of a company's profits because (as far as lenders are concerned) this is the amount a company has to pay any loans that are made to it - the money you have before you pay out interest, taxes and account for depreciation and amortization.
I've never liked the concept of depreciation and amortization. I do understand the "matching" principle of accounting in that you spread out the cost of long term fixed assets to match the overall expense with the revenue it helps generate over the years, but for larger companies that are always buying fixed assets to replace the old ones, would simply expensing your purchases outright really make any difference between your cash flow and net income.
I also have a distaste for EBITDA because it was always used by bankers as the measure to see how much debt a company could afford. LITERALLY ignoring the fact the company would have to spend some money SOMETIME in order to keep its operations going. So if you based your loan on the amount EBITDA showed, you were pretty much guaranteed to be lending beyond the payback capacity of the borrower.
Alas, it was these sort of "rocking the boat" observations that attracted the criticism of my now insolvent previous employers, but as Steve Wynn has pointed out the "City Center" project which was financed by the likes of my previous employers, is belly up and bankrupt.
3 comments:
I always understood depreciation and amortization to be tax driven, not accounting driven. The only reason you want to account for assets over time, because it is usually a pain in the rear, is because the tax authorities want was much tax from you, earlier. Also, the years give government the opportunity to inflate away the value of your deductions. For example, the present value of $100k in depreciation amortized over 40 years (the current depreciation period for commercial real estate) is $30,164.56 at 3% inflation. Nearly 70% of the value of your depreciation deduction has been stolen from you.
Government, of course, treats itself differently. In government accounting, fixed assets are expensed in the year acquired.
Cap't
As an accountant, I understood both the rational behind an economic depreciation of assets and the accounting side of it. You questioned what purpose there was in a business that constantly replaces assets, and as such, keeps a high level of depreciation, but realistically, the point of depreciation is to ensure that the true cost of the property plant or equipment is allocated to each period regardless of if any replacement capital was spent. In essence, it is a way to ensure that financial information can't be manipulated in order to give users the wrong impression about the economic reality of the business and its future prospects.
I agree with you that EBITDA is misleading in that taxes are something that need to be paid, and as such, should be excluded from the calculation.
In the near future, you will start to see accounting standards move towards a more economic representation of net income, and at that time, I would be surprised if the banks don't change their ratios accordingly.
Well, if a credit analyst is doing their job properly they're not just going to look at EBITDA. They are going to look at a variety of ratios and projections of income which measure the ability to repay debt.
They're also going to look at the interest coverage ratio, making sure they adjust for leases.
They're also going to look at Free Cash Flow to the Firm and coverage ratios based on cash flows.
There are treatments and adjustments to these ratios which make them more conservative. All of the information necessary to make these adjustments are required reporting.
Debt issuance can also have performance and activity covenants such as minimum coverage ratios, maximum debt ratios, prohibition against issuing additional debt or distributing dividends, or pledging of assets.
When the credit analyst is under the thumb of the salesmen (or worse, on commission) then all they're doing is cherry picking the right numbers to justify a foregone conclusion.
Oxygentax is right. Accounting standards are moving toward economic reality.
Bank assets are mostly loans which don't depreciate. As far as I know, they own few assets subject to depreciation or amortization. It's more likely that they have assets subject to impairment or write-downs which are sort-of a massive, lump-sum amortization or depreciation. Right now banks are getting scorched from writedowns on REO and provisions for nonaccruing loans.
Randian, US companies can use different rates of depreciation for tax and financial reporting although the method (FIFO, LIFO) must match. The resulting temporary differences create deferred tax liabilities on the balance sheet. A firm which is constantly replacing rapidly-depreciating capital can actually defer taxes indefinitely. IFRS is far less forgiving to this accounting treatment because the social welfare states want their tax money now.
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