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Strips financing decisions and non-cash charges from earnings to isolate the cash-generating capacity of operations independent of capital structure.
EBITDA is earnings before interest, taxes, depreciation and amortization. It shows operating performance before non-cash charges and is often used in valuations.
EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortisation) measures operating profitability before certain non-operating expenses and non-cash charges. This metric approximates cash generation from core operations, making it popular for valuation, debt capacity analysis, and comparing companies with different capital structures and depreciation policies.
The calculation starts with net income and adds back excluded items:
EBITDA = Net Income + Interest + Taxes + Depreciation + Amortisation EBITDA = Operating Income + Depreciation + Amortisation
For example, if operating income is $80 million and D&A is $20 million, EBITDA is $100 million.
Why EBITDA is widely used:
- Capital structure neutral: Excludes interest, enabling comparison regardless of debt levels
- Accounting policy neutral: Removes depreciation differences from different asset ages or accounting methods
- Cash flow proxy: Approximates operating cash before working capital changes
- M&A standard: Common basis for acquisition valuations (EV/EBITDA multiples)
- Debt covenant metric: Often used in credit agreements (Debt/EBITDA ratios)
Important criticisms and limitations:
- Ignores capital requirements: Some businesses need continuous reinvestment that EBITDA overlooks
- Not actual cash flow: Working capital changes, taxes, and interest still consume cash
- Manipulation risk: "Adjusted EBITDA" can add back questionable items
- Warren Buffett's critique: "Does management think the tooth fairy pays for capital expenditures?"
Adjusted EBITDA commonly excludes:
- Stock-based compensation
- Restructuring charges
- Acquisition-related costs
- One-time gains or losses
Be sceptical of heavily adjusted EBITDA figures. If "one-time" charges occur every year, they're operating costs, not adjustments. Compare company-calculated EBITDA to your own calculation using reported financials. For capital-intensive businesses, free cash flow is typically more relevant than EBITDA for assessing value creation.
How it relates
EBITEBIT is earnings before interest and taxes. It measures operating profitability and is widely used to compare companies with different financing structures.+Depreciation & AmortizationDepreciation and amortization are non-cash expenses that spread the cost of assets over time. They reduce reported profit but do not use cash in the current period, so they are added back when calculating cash flow.=EBITDA
Enterprise ValueEnterprise value estimates the total value of the business, including debt and excluding cash. It's often seen as the price a buyer would pay to acquire the whole company.÷EBITDA=Enterprise to EBITDAEnterprise value to EBITDA compares the value of the company to its earnings before interest, taxes, depreciation and amortization. It's often used to compare valuations across companies and industries.