Business, Legal & Accounting Glossary
EBITDA, or Earnings Before Interest, Taxes, Depreciation and Amortization,is a measure of a company’s cash flow before certain deductions. It allows investors to see how much money a company is making by computing earnings from core business operations, without including the effects of capital structure, tax rates and depreciation policies. Note: EBITDA is a “calculated” indicator that is not defined under Generally Accepted Accounting Principles (GAAP).
EBITDA or “earnings before interest taxes depreciation and amortization” is a commonly used measure of cash flow. EBITDA can be calculated “top-down” by adding back DDA or depreciation and amortization deducted as sales costs to operating income before interest and taxes. EBITDA can also be calculated “bottom-up” by adding interest and DDA back to pretax income. For example, to find EBITDA, if the income statement shows $2 million of pretax income and DDA is $12 million and interest expense $6 million, then EBITDA is $20 million. EBITDA became a standard tool for measuring cash flow leverage for LBOs in the 1980s. An EBITDA/debt ratio at a 2x multiple was considered the limit of safe leverage. EBITDA is often the cash flow measure most often associated with profitability comparison between investments. For example, enterprise value/EBITDA provides a valuation multiple of all of a company’s debt and equity times its cash flows. EBITDA is not a GAAP approved accounting measure because EBITDA neutralizes the effects of a company’s financing and accounting decisions.
EBITDA gives the investor an idea of how much money the company has made before its deductions. It is especially useful for a new company that has just started business and has not yet been hit with taxes, payments to creditors, and so on. EBITDA demonstrates to investors the ability to have a return on their investments.
EBITDA is a rough approximation for cash flow; it ignores many factors that have an impact on true cash flow, such as debt payments. Even so, it may be useful for evaluating firms in the same industry with widely different capital structures, tax rates, and depreciation policies. EBITDA is often used in various evaluating ratios, such as EV/EBITDA and EBITDA margins.
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This glossary post was last updated: 22nd March, 2020