Sheryl Sandberg's Magic Facebook Finances

Facebook is already missing its CFO. Sheryl Sandberg, the social network's publicity-hungry COO now tells BusinessWeek that the money-losing social network is "profitable." Not because its revenues exceed its expenses, but because she says so!

Here's Sandberg:

We don't have the need for additional financing. With our current business model, our current plans, we are profitable, on a clear path to being cash-flow positive. We're not short of money. We're doing really well financially in what is a really tough year. Every advertiser segment is growing-we're growing all over internationally. The ad products are really working for people, and they want to do more and more.

This is the first time a Facebook executive has claimed that the social network is "profitable" — a term usually reserved for companies which can show net income according to the strict GAAP standards.

Here's what Sandberg's boss, CEO Mark Zuckerberg, said last week:

Based on our first quarter results, we now believe we are on track to see our revenue grow by at least 70% this year. We just completed our fifth straight quarter of EBITDA profitability. And most importantly, we expect to achieve free cash flow profitability next year.

EBITDA stands for earnings before interest, tax, depreciation, and amortization. It's a handy measure for Facebook, which is believed to be spending hundreds of millions of dollars a year on servers, to make its finances look better. But it's not the same thing as actual profit.

Oh, haha, she forgot a funny-sounding word! Not so funny, actually. Here's what renowned investor Warren Buffett has to say about "EBITDA profitability" in his 2000 and 2002 annual reports to Berkshire Hathaway shareholders:

References to EBITDA make us shudder — does management think the tooth fairy pays for capital expenditures? We're very suspicious of accounting methodology that is vague or unclear, since too often that means management wishes to hide something.

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?

Oh, and then there's Lynn Turner, the former chief accountant of the SEC, who blamed investors' reliance on EBITDA figures for financial fraud at Enron, WorldCom, and Sunbeam.

We have a suggestion for Sandberg: Try an exciting new measure of profitability we call "earnings before expenses." It was all the rage in the 1990s.