EBITDA

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.