Julian Shocron: What EBITDA Tells You, and What It Hides
Julian Shocron writes plain-language notes on finance. This one covers EBITDA: what it measures, how to calculate it, and why it should never be read alone.
The acronym
EBITDA stands for Earnings Before Interest, Taxes, Depreciation and Amortization. It strips out how a company is financed, where it pays taxes, and the accounting wear of its assets, to show what day-to-day operations produce.
Two ways to get there
- Top-down: revenue minus cost of goods sold minus operating expenses, leaving out depreciation and amortization.
- Bottom-up: net income plus interest, taxes, depreciation and amortization.
A worked example (made-up numbers, for illustration only)
| Item | Amount |
|---|---|
| Net income | 100 |
| Interest | 20 |
| Taxes | 30 |
| Depreciation (oven) | 15 |
| Amortization (point-of-sale software) | 5 |
| EBITDA | 170 |
A fictional bakery keeps 100 at the bottom line, but its operations generate 170 before those four items.
Where it helps
- Comparing businesses in the same industry with different debt or tax situations.
- Gauging leverage: debt divided by EBITDA gives a rough sense of how heavy the debt is.
- Valuation: many deals are quoted as a multiple of EBITDA.
What it hides
- Cash. A company can post strong EBITDA and still run out of money if customers pay late.
- Reinvestment. Ovens wear out. Replacing them costs real money that EBITDA ignores.
- Standards. EBITDA is not an official accounting measure, which is why "adjusted EBITDA" varies so much from one company to another.
That is why EBITDA belongs next to free cash flow, which tracks the money that actually remains.
In short
EBITDA measures operating earnings before financing, taxes and non-cash charges. It is useful for comparison, but it is not cash and it is not the whole story.
Educational note by Julian Shocron. Not investment advice.
More notes: julianshocron.com/en