EBITDA, short for Earnings Before Interest, Taxes, Depreciation, and Amortization, is one of the most widely used metrics in investing and corporate finance. It strips away financing, tax, and non-cash accounting decisions, giving investors and analysts a clearer view of a company’s true operating performance.
If you want to know how much money a business makes from running its core operations before financial engineering and tax strategies muddy the waters, EBITDA is your go-to metric.
What Is EBITDA?
EBITDA is essentially the profit a company generates before:
- Interest: Costs of borrowing money.
- Taxes: Income taxes owed to the government.
- Depreciation: Gradual expense of physical assets like machinery or buildings.
- Amortization: Gradual expense of intangible assets like patents or trademarks.
By removing these factors, EBITDA allows you to see operational profitability without distortions from financing choices or tax environments.
Key Insight: Two companies in the same industry might have very different net incomes due to debt levels or tax rates, but their EBITDA figures could reveal that they’re equally efficient at generating operating profits.
EBITDA Formula
There are two main ways to calculate EBITDA:
1. From Net Income:
EBITDA = Net Income + Interest + Taxes + Depreciation + Amortization
2. From Operating Income (EBIT):
EBITDA = Operating Income + Depreciation + Amortization
Example Calculation:
A manufacturing company reports:
- Revenue: $2,000,000
- COGS: $1,000,000
- Operating Expenses (excl. depreciation): $400,000
- Depreciation: $50,000
- Amortization: $20,000
- Interest Expense: $30,000
- Taxes: $40,000
Step 1: Find Operating Income (EBIT)
EBIT = Revenue − COGS − Operating Expenses − Depreciation − Amortization
EBIT = 2,000,000 − 1,000,000 − 400,000 − 50,000 − 20,000 = 530,000
Step 2: Add Back Depreciation & Amortization
EBITDA = 530,000 + 50,000 + 20,000 = 600,000
So, EBITDA = $600,000.
Why Investors Use EBITDA
1. Comparability Across Companies
EBITDA strips out financing and tax factors, making it easier to compare companies in different countries or with different debt structures.
2. Closer to Cash Earnings
Because it removes non-cash charges like depreciation, EBITDA can approximate cash operating performance, though it’s not a substitute for actual cash flow.
3. Valuation Tool
EBITDA is often paired with Enterprise Value (EV) in the EV/EBITDA multiple, a standard in mergers, acquisitions, and investment banking.
EBITDA vs. EBIT vs. Net Income
| Metric | Includes / Excludes | Purpose |
|---|---|---|
| Net Income | Includes all expenses (interest, taxes, depreciation, amortization) | Final profitability |
| EBIT | Excludes interest & taxes, but includes depreciation & amortization | Operating profit |
| EBITDA | Excludes interest, taxes, depreciation, and amortization | Core operational profitability |
Visual Aid: (Use the infographic generated earlier comparing EBT, EBIT, and EBITDA.)
Limitations of EBITDA
While EBITDA is useful, it’s not perfect:
- Ignores Capital Expenditures – Replacing machinery or upgrading facilities costs real money, even if depreciation is non-cash.
- Not a GAAP Metric – It’s not regulated, so companies can manipulate how they calculate it.
- Can Overstate Profitability – A high EBITDA doesn’t always mean strong financial health.
- Criticized by Experts – Warren Buffett once called EBITDA “earnings before everything you don’t like.”
Practical Uses in Investing
- Valuation: EV/EBITDA is a standard ratio for comparing businesses.
- Debt Capacity: Lenders often look at EBITDA to judge repayment ability.
- M&A Deals: Buyers use EBITDA multiples to estimate acquisition prices.
- Benchmarking: Compare EBITDA margins between peers to spot operational strengths or weaknesses.
EBITDA Margin
The EBITDA margin shows how much EBITDA is generated as a percentage of revenue:
EBITDA Margin = (EBITDA ÷ Revenue) × 100If a company has $600,000 EBITDA on $2,000,000 revenue:
Example:
EBITDA Margin = (2,000,000 ÷ 6,000,000) × 100 = 30%Higher margins often indicate better operational efficiency.
When to Rely on EBITDA (and When Not To)
Useful:
- Comparing similar companies across regions.
- Assessing core operating performance.
- Early-stage valuation discussions.
Not Enough Alone:
- For businesses with heavy capital expenses (e.g., airlines, manufacturing).
- For companies with volatile working capital needs.
Conclusion
EBITDA is a powerful lens for looking at a company’s operational performance, but it’s not the whole picture. Use it alongside cash flow, debt ratios, and profit margins to get a well-rounded view.
By understanding what EBITDA is and what it isn’t, you’ll be better equipped to make smart, informed investment decisions.
