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What is EBITDA?

Highlighted from a real earnings story. Explained by Clicked.

Used in a sentence

The Daily Ledger · Markets

The company reported record EBITDA for the quarter, though it has still not turned a profit.

The reader highlighted one word mid-article. Clicked explained the finance term “EBITDA” in plain language:

Explained in three depths

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Overview

EBITDA is what a company earns before interest, tax, depreciation and amortization are taken out. Those four costs depend on how a business was funded and where it pays tax, not on how well it trades. Remove them and two rivals become comparable. It is the most quoted profit figure in finance and the most argued over, because the costs it removes are real ones somebody still pays.
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Overview

EBITDA is what a business makes before four deductions: what it owes lenders, what it owes the tax authority, and two charges called depreciation and amortization. Those last two spread the cost of past purchases across the years the company keeps using them. Bankers reach for it because rivals finally line up on one scale. Critics call it a mass delusion. Both camps are right, which is pretty much the whole story of this number. 😎

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Detail

The letters stand for earnings before interest, taxes, depreciation and amortization, and each one comes out for a reason. Interest depends on the company's borrowings. Tax depends on the country and the year. Depreciation and amortization spread the cost of something bought in an earlier year across the years it gets used, so a company that bought its machines in 2019 still carries a charge that a rival renting the same machines never shows. What remains is close to what the company itself produced. That is why EBITDA is used to compare rivals carrying different debts, to price a business as a multiple of earnings, and to write loan tests a borrower cannot pass by refinancing. One objection matters more than the rest. Depreciation is the estimate of a replacement bill that has not arrived yet, so taking it out removes the warning rather than the cost. A company reporting strong EBITDA while its equipment ages is spending its own future. EBITDA is not cash either. Interest and tax are both paid in cash and both are excluded, and a growing business ties up more cash still in inventory and in invoices customers have not paid.
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Detail

EBITDA is profit before interest, tax, depreciation and amortization. Those last two are the charges for machines, software and anything else bought in an earlier year. Strip all four and what is left is roughly what the business itself did. Here is why anyone bothers. Every bottom line has been shoved around by decisions with nothing to do with running the place. Borrowed heavily? Big interest bill. Based somewhere with cheap tax? Smaller tax bill. Bought your equipment outright in 2019? You are still writing that purchase down today, while the company across the road renting the same kit is not. Now the catch. Those machines wear out, and the write-down you just removed was the signal that a replacement bill is coming. Removing the signal does not remove the bill. There is also no rulebook, because EBITDA is not an official accounting measure and every company defines its own version. That is how adjusted EBITDA ends up doing heroic work in a pitch deck, and why loan documents spend a page spelling out which one they mean. 😎

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Analogy

Two gyms open on the same street with the same machines and the same prices. One owner paid cash for the equipment. The other borrowed, and pays the lender every month. The second reports the smaller profit, though neither is run any differently. EBITDA removes exactly that difference: subtract wages, rent and electricity from each gym's income, and stop there. Both land in the same place, which answers which gym is better run. What it cannot tell you is what both gyms share. Treadmills last around seven years, and each owner faces the same bill in year eight. EBITDA does not show that bill for either of them.
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Analogy

A flight advertised at $49 is not a lie. That is the fare, and the fare is a real number. It is also nowhere near what leaves your account once the taxes, the seat and the bag go on. EBITDA is the $49. Perfectly good for holding one airline's fare against another's, useless for working out what the trip costs you. The trouble starts the moment somebody quotes the $49 and lets you assume it was the total, which is roughly the business model of every pitch deck ever made. 😎
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AI explanations may contain errors · Not professional advice

Formal definition — The same term, explained the usual way

EBITDA denotes earnings before interest, taxes, depreciation and amortization. It is a non-GAAP measure obtained by adding depreciation and amortization charges back to operating profit, thereby removing the effects of capital structure, tax jurisdiction and the accounting treatment of prior capital expenditure. It is applied widely in leverage covenants and transaction multiples, where a standardised earnings base permits comparison across entities. It is not a measure of cash flow, it excludes working capital movements and capital expenditure, and it is not defined uniformly across reporting entities.

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