What Is EBITDA?
Let me explain EBITDA directly to you: it's earnings before interest, taxes, depreciation, and amortization, an alternative way to gauge a company's profitability beyond just net income. I use it to evaluate financial performance without those specific costs muddying the picture. Remember, it's not a GAAP-recognized metric, so some companies report it alongside adjusted versions that exclude things like stock-based compensation. I've seen increased focus on EBITDA lead to criticism that it overstates profitability, and the SEC requires companies to show how they derive it from net income without per-share reporting.
Formula and Calculation
You can calculate EBITDA easily if you have the financial statements. The two main formulas are straightforward: EBITDA equals net income plus taxes, interest expense, and depreciation and amortization, or alternatively, operating income plus depreciation and amortization. You'll find net income, taxes, and interest on the income statement, with depreciation and amortization often in the notes or cash flow statement. I recommend using software like Excel for this—it's simple and keeps things accurate.
What Does EBITDA Tell You?
EBITDA lets you track and compare underlying profitability across companies, ignoring differences in depreciation assumptions or financing choices. I often see it in valuation ratios like EV/EBITDA for enterprise multiples. It's particularly relevant in asset-heavy industries where high depreciation might hide true operational strength, like in energy or tech sectors. By excluding taxes and interest, it focuses on cash profits from business operations, though not everyone agrees—Warren Buffett, for instance, calls it meaningless for omitting real costs like depreciation.
Example
Consider this example to see EBITDA in action: if a company has $100 million in revenue, $40 million in cost of goods sold, $20 million in overhead, and $10 million in depreciation and amortization, that gives an operating profit of $30 million. Add $5 million interest and a 20% tax on $25 million pretax income, netting $20 million. Adding back depreciation, amortization, interest, and taxes to net income gets you $40 million in EBITDA. That's how it works—straightforward addition to reveal core earnings.
History
EBITDA was invented by John Malone in the 1970s to pitch his leveraged growth strategy in the cable industry, using debt and reinvested profits to cut taxes. In the 1980s, it became key for leveraged buyouts to check if companies could service acquisition debt, excluding interest, taxes, and non-cash costs. It gained notoriety in the dotcom bubble for exaggerating performance and again in 2018 with WeWork's 'Community Adjusted EBITDA' that excluded major expenses.
Drawbacks
EBITDA has real drawbacks you need to watch for. As a non-GAAP measure, calculations vary, and companies might emphasize it to look better than their net income suggests—especially if they've borrowed heavily or face rising costs. It ignores asset costs, treating them like they're free, which Buffett criticizes harshly. Earnings figures can be manipulated, and using EBITDA for valuation can make companies seem cheaper than they are, as seen with Sprint Nextel's multiples. Relying solely on it risks missing the full picture.
EBITDA vs. EBIT vs. EBT
Let me break down the differences: EBIT is net income plus interest and tax expenses, focusing on core operations. EBT adds only taxes back to net income, useful for comparing across tax jurisdictions. Unlike EBITDA, both include depreciation and amortization as non-cash expenses. You calculate EBIT by adding interest and taxes to net income, and EBT by adding just taxes—EBITDA goes further by excluding those non-cash items too.
EBITDA vs. Operating Cash Flow
Operating cash flow is a stronger indicator of actual cash generation because it adds back non-cash charges but also accounts for working capital changes like receivables and inventory. EBITDA ignores these, so if you rely only on it, you might miss issues like collection problems affecting cash flow. I advise including working capital trends in your analysis for a complete view.
FAQs
- How Do You Calculate EBITDA? The formula is operating income plus depreciation and amortization, pulled from income, cash flow, and balance sheets.
- What Is a Good EBITDA? Aim for at least twice the interest expense, or margins above 15% in some industries, depending on factors like size and capital structure.
- What Is the Difference Between EBITDA and EBITA? EBITA excludes depreciation, making it less common but potentially useful for companies without heavy capital expenditures.
- Is EBITDA the Same As Gross Profit? No, gross profit is revenue minus COGS, while EBITDA excludes more expenses for a view of operational profitability.
- What Is Amortization in EBITDA? It's the gradual write-down of intangible assets like patents, added back since it's non-cash.
The Bottom Line
EBITDA is a tool for comparing companies with different taxes or capital costs, omitting non-cash depreciation that might not reflect future spending. But it opens doors for abuse by managers excluding costs selectively, so always reconcile it to net income in the fine print to avoid misleading figures.
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