A company's earnings before interest, taxes, depreciation, and amortization is an accounting
measure calculated using a company's net earnings, before interest expenses, taxes, depreciation
and amortization are subtracted, as a proxy for a company's current operationing profitability,
i.e., how much profit it makes with its present assets and its operations on the products
it produces and sells, as well as providing a proxy for cash flow.
Although EBITDA is not a financial measure recognized in generally accepted accounting
principles, it is widely used in many areas of finance when assessing the performance
of a company, such as securities analysis.
It is intended to allow a comparison of profitability between different companies, by discounting
the effects of interest payments from different forms of financing, political jurisdictions,
collections of assets, and different takeover histories.
EBITDA is a financial measurement of cash flow from operations that is widely used in
Mergers and Acquisitions of small businesses and businesses in the middle market.
It is not unusual for adjustments to be made to EBITDA to normalize the measurement which
allows buyers to compare the performance of one business to another.
A negative EBITDA indicates that a business has fundamental problems with profitability
and cash flow.
A positive EBITDA, on the other hand, does not necessarily mean that the business generates
cash.
This is because EBITDA ignores changes in Working Capital, capital expenditures, taxes,
and interest.
Some analysts do not support omission of capital expenditures when evaluating the profitability
of a company: capital expenditures are needed to maintain the asset base which in turn allows
for profit.
Warren Buffett famously asked: "Does management think the tooth fairy pays for capital expenditures?"
Depreciation is often a very good approximation of the capital expenditures required to maintain
the asset base, so it has been argued that EBITA would be a better indicator.
EBITDA margin refers to EBITDA divided by total revenue.
Use Apart from the use mentioned above, EBITDA
is widely used in loan covenants, mostly in the following two metrics:
Leverage: Debt/EBITDA.
This metric measures the amount of debt in relation to the EBITDA.
Whilst there is no absolute target and whilst leverage ratios differ widely, it can probably
be argued that a leverage >3 is unhealthy for most businesses.
Interest Cover:.
This metric measures the ability of a company to generate profit out of its operations to
cover interest payments.
Again, there is no absolute target for this value, as the ratio that is required obviously
depends on taxes, working capital needs, capital expenditures and the repayment needs of the
principal.
However, it is clear that a ratio <1 is not sustainable for long.
Misuse EBITDA has increasingly become the key metric
to show the "intrinsic operational performance" of the business, i.e., the performance when
all costs that do not occur in the normal course of business are ignored.
While this is helpful in general, it is often misused by declaring too many cost items as
"one-offs" and thus boosting profitability.
The resulting metric when such "non-normal" costs have been deducted should be called
"adjusted EBITDA" or similar, but this "adjusted" nature is often not shown sufficiently clearly.
Because EBITDA are not measures generally accepted under U.S. GAAP, the U.S. Securities
and Exchange Commission requires that companies registering securities with it reconcile EBITDA
to net income in order to avoid misleading investors.
In another attempt to boost EBITDA, some companies have reverted to activate development efforts
in the profit and loss statement.
This effectively increases total output and hence increases EBITDA.
Such development costs are then recorded as capital expenditures.
Instead of EBITDA, a view on EBITA would eliminate such an artifact.
See also Earnings Before Interest, Taxes, Depreciation,
Amortization, and Restructuring or Rent Costs Earnings before interest and taxes, or operating
profit EV/EBITDA
Gross profit Net profit or Net income
OIBDA Operating margin
P/E ratio Revenue
References
External links Investopedia definition of EBITDA