What you will learn
- Say what EBITDA stands for and calculate it from net income
- Explain why analysts use it to compare companies
- Understand the well-known criticism that it hides real costs
- Know that EBITDA is not a GAAP measure and can be presented to flatter results
Few terms get thrown around finance as casually, or as much argued over, as EBITDA. It is useful for some comparisons and misleading in others, so a good analyst learns both what it shows and what it leaves out. Since you just learned about depreciation and amortization, you are perfectly placed to understand it, because those are the D and the A in the name.
EBIT and EBITDA: what they are and why they matter (The Finance Storyteller)
Builds EBITDA step by step from the income statement. Watch how each of the four items is added back.
What it stands for
EBITDA is earnings before interest, taxes, depreciation, and amortization. You can build it two ways: start from operating income and add back depreciation and amortization, or start from net income and add back interest, taxes, and D&A. Either way, the idea is to strip out those four items and look at a rawer measure of how profitable the core operations are.
Key terms
- EBITDA
- Earnings before interest, taxes, depreciation, and amortization. A measure of core operating profitability.
- Capital structure
- The mix of debt and equity a company uses to finance itself. Interest depends on it.
- Adjusted EBITDA
- A company-defined version of EBITDA that adds back even more items, which can flatter results.
- Non-GAAP measure
- A figure not defined by the official accounting rules, so companies present it with some leeway.
Building EBITDA from net income
A company reports net income of 100,000 dollars. Its income statement shows interest of 20,000, taxes of 25,000, and depreciation and amortization of 55,000. What is its EBITDA?
- Start at the bottom line. Net income is 100,000 dollars.
- Add back interest and taxes. 100,000 plus 20,000 interest plus 25,000 taxes is 145,000, which is EBIT.
- Add back depreciation and amortization. 145,000 plus 55,000 of D&A is 200,000.
Why it matters: EBITDA adds four things back to net income. Notice how much bigger it looks than the 100,000 net income, which is exactly why it must be read with care.
Calculate EBITDA
A company has net income of 60,000 dollars, interest of 15,000, taxes of 20,000, and depreciation and amortization of 35,000. What is its EBITDA?
Why anyone uses it
- Removing interest cancels out differences in how companies are financed, so you can compare operations regardless of debt levels.
- Removing taxes cancels out differences in tax rates and one-off tax effects.
- Removing depreciation and amortization strips out large non-cash charges, getting closer to operating cash generation.
- The result is often used as a quick proxy for operating cash flow and to compare companies on a like-for-like operating basis.
EBITDA asks: ignoring how you are financed and taxed, and setting aside non-cash charges, how profitable are the core operations?
The famous critique
EBITDA has prominent critics, including Warren Buffett and Charlie Munger, for one main reason: depreciation represents a real cost. Equipment wears out and eventually must be replaced, and that replacement is genuine cash a business has to spend to survive. By adding D&A back, EBITDA can make a capital-heavy business look far healthier than the cash it actually generates. Munger memorably suggested replacing the term with earnings before the costs we would rather you ignore.
EBITDA explained (Wall Street Prep)
A concise, professional definition and build-up. Watch for the caution that EBITDA is not the same as cash flow.
When EBITDA flatters
A capital-heavy manufacturer reports strong and rising EBITDA every year, but it must spend huge amounts replacing worn-out equipment. Why might EBITDA give a misleading picture of its health?
For a capital-heavy business, adding back depreciation hides the real, recurring cash needed to replace equipment, so EBITDA can overstate its health.What does each letter add back?
EBITDA adds four items back to profit. Match each one to what it represents.
Use it carefully
EBITDA is not a GAAP measure, which means companies have leeway in how they present it. Some add back more and more items to flatter results, producing what is called adjusted EBITDA. Treat EBITDA as one tool among many, useful for comparing operating performance across companies with different financing, but never as a substitute for free cash flow, the very next lesson, which respects the capital a business must actually reinvest.
EBITDA deliberately ignores capital spending. Free cash flow, which we turn to now, puts that spending right back in, which is why many investors trust it more.