Ebitda

What is EBITDA?
EBITDA stands for Earnings Before Interest, Taxes, Depreciation, and Amortization and is a metric used
to evaluate a company’s operating performance. It can be seen as a proxy for cash flow from the entire
company’s operations.
The EBITDA metric is a variation of operating income (EBIT) that excludes non-operating expenses and
certain non-cash expenses. The purpose of these deductions is to remove the factors that business
owners have discretion over, such as debt financing, capital structure, methods of depreciation, and
taxes (to some extent). It can be used to showcase a firm’s financial performance without accounting for
its capital structure.
EBITDA focuses on the operating decisions of a business because it looks at the business’ profitability
from its core operations before the impact of capital structure, leverage, and non-cash items such as
depreciation are taken into account.
It is not a recognized metric in use by IFRS or US GAAP. In fact, certain investors like Warren Buffet have
a particular disdain for this metric, as it does not account for the depreciation of a company’s assets. For
example, if a company has a large amount of depreciable equipment (and thus a high amount of
depreciation expense), then the cost of maintaining and sustaining these capital assets is not captured.
EBITDA Formula
Here is the formula for calculating EBITDA:
EBITDA = Net Income + Interest + Taxes + Depreciation + Amortization
OR
EBITDA = Operating Profit + Depreciation + Amortization
Below is an explanation of each component of the formula:

Interest
Interest is excluded from EBITDA, as it depends on the financing structure of a company. It comes from
the money it has borrowed to fund its business activities. Different companies have different capital
structures, resulting in different interest expenses. Hence, it is easier to compare the relative
performance of companies by adding back interest and ignoring the impact of capital structure on the
business. Note that interest payments are tax-deductible, meaning corporations can take advantage of
this benefit in what is called a corporate tax shield.
Taxes
Taxes vary and depend on the region where the business is operating. They are a function of tax rules,
which are not really part of assessing a management team’s performance and, thus, many financial
analysts prefer to add them back when comparing businesses.
Depreciation & Amortization
Depreciation and amortization (D&A) depend on the historical investments the company has made and
not on the current operating performance of the business. Companies invest in long-term fixed assets
(such as buildings or vehicles) that lose value due to wear and tear. The depreciation expense is based
on a portion of the company’s tangible fixed assets deteriorating. Amortization expense is incurred if the
asset is intangible. Intangible assets such as patents are amortized because they have a limited useful
life (competitive protection) before expiration.
D&A is heavily influenced by assumptions regarding useful economic life, salvage value, and the
depreciation method used. Because of this, analysts may find that operating income is different than
what they think the number should be, and therefore D&A is backed out of the EBITDA calculation.
The D&A expense can be located in the firm’s cash flow statement under the cash from operating
activities section. Since depreciation and amortization is a non-cash expense, it is added back (the
expense is usually a positive number for this reason) while on the cash flow statement.
Why Use EBITDA?
The EBITDA metric is commonly used as a proxy for cash flow. It can give an analyst a quick estimate of
the value of the company, as well as a valuation range by multiplying it by a valuation multiple obtained
from equity research reports, industry transactions, or M&A.
In addition, when a company is not making a profit, investors can turn to EBITDA to evaluate a company.
Many private equity firms use this metric because it is very good for comparing similar companies in the
same industry. Business owners use it to compare their performance against their competitors.
Disadvantages
EBITDA is not recognized by GAAP or IFRS. Some are skeptical (like Warren Buffett) of using it because it
presents the company as if it has never paid any interest or taxes, and it shows assets as having never
lost their natural value over time (no depreciation or Capital Expenditures deducted).
For example, a fast-growing manufacturing company may present increasing sales and EBITDA year over
year (YoY). To expand rapidly, it acquired many fixed assets over time and all were funded with debt.
Although it may seem that the company has strong top-line growth, investors should look at other
metrics as well, such as capital expenditures, cash flow, and net income.
Video Explanation of EBITDA
Below is a short video tutorial of Earnings Before Interest, Taxes, Depreciation, and Amortization. The
short lesson will cover various ways to calculate it and provide some simple examples to work through
EBITDA Used in Valuation (EV/EBITDA Multiple)
When comparing two companies, the Enterprise Value/EBITDA ratio can be used to give investors a
general idea of whether a company is overvalued (high ratio) or undervalued (low ratio). It’s important
to compare companies that are similar in nature (same industry, operations, customers, margins, growth
rate, etc.), as different industries have vastly different average ratios (high ratios for high-growth
industries, low ratios for low-growth industries).
The metric is widely used in business valuation and is found by dividing a company’s enterprise value by
EBITDA.
EV/EBITDA Example:
Company ABC and Company XYZ are competing grocery stores that operate in New York. ABC has an
enterprise value of $200M and an EBITDA of $10M, while firm XYZ has an enterprise value of $300M and
an EBITDA of $30M. Which company is undervalued on an EV/EBITDA basis?
EBITDA in Financial Modeling
EBITDA is used frequently in financial modeling as a starting point for calculating un-levered free cash
flow. Earnings before interest, taxes, depreciation, and amortization is such a frequently referenced
metric in finance that it’s helpful to use it as a reference point, even though a financial model only
values the business based on its free cash flow.

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What is EBITDA?

Here is the formula for calculating EBITDA:

EBITDA = Net Income + Interest + Taxes + Depreciation + Amortization

EBITDA = Operating Profit + Depreciation + Amortization

Below is an explanation of each component of the formula:

Depreciation & Amortization

Why Use EBITDA?

Video Explanation of EBITDA

EBITDA Used in Valuation (EV/EBITDA Multiple)

EBITDA in Financial Modeling

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