EBITDA: what it means, how it is calculated and when it is introduced

EBITDA ( Earnings Before Interest, Taxes, Depreciation and Amortization) is a measure that approximates a company’s operating performance before the impact of financing (interest), taxes and non-cash expenses (depreciation and amortization). In practice, it is mainly used for quick comparisons of firms within an industry, in investment analyses and in business valuations (e.g. via EV/EBITDA).

Why EBITDA is important for companies and investors

Comparison of operational performance

EBITDA helps to compare companies without significantly affecting the result:

• amount of debt (interest),
• different tax environments,
• accounting depreciation (which is non-cash).

Frequent basis for valuing companies (EV/EBITDA)

For M&A and investments, an EV/EBITDA (enterprise value/EBITDA) multiple is often used to allow relative valuation comparisons between companies in the same sector.

What exactly EBITDA represents (and what it doesn’t)

EBITDA is not cash flow.
It is an income-cost ratio, which, although it excludes depreciation and amortization (non-cash items), still:

• ignores CAPEX (real investment in assets),
• does not take account of changes in working capital (inventories, accounts receivable, accounts payable),
• says nothing about repaying the debt.

Therefore, it is always advisable to supplement EBITDA with other indicators (e.g. operating cash flow, free cash flow, net profit).

How EBITDA is calculated

1) EBITDA from EBIT

If you have EBIT (earnings before interest and tax), the calculation is:

EBITDA = EBIT + depreciation + amortisation (amortisation of intangible assets)

2) EBITDA from net profit

If you are basing it on net profit (after tax), a simplification typically applies:

EBITDA = net profit + interest + taxes + depreciation + amortisation

Note: in practice, care should be taken with exceptional/unusual items and ‘adjusted’ definitions (e.g. adjusted EBITDA).

Practical example of EBITDA calculation

Imagine a company with the following data:

• Net profit: 100 000 €
• Interest: €20 000
• Data: 15 000 €
• Depreciation: € 10 000
• Amortisation: € 5 000

EBITDA = 100 000 + 20 000 + 15 000 + 10 000 + 5 000 = € 150 000

EBITDA vs. EBIT vs. net profit

• EBITDA: “earnings before interest, taxes, depreciation and amortization” – useful for comparing companies and quick screening.
• EBIT: earnings before interest and tax – already includes depreciation and amortisation, so it is more reflective of the “costliness” of assets.
• Net profit: the result after all costs – important for overall profitability, but affected by financing, taxes and accounting policies.

When EBITDA is useful (and when it can be misleading)

EBITDA is useful when:

• you are comparing companies in the same industry,
• you are assessing the ability to generate an operating result,
• you do the valuation via EV/EBITDA,
• you are tracking debt through Debt/EBITDA.

EBITDA can be misleading when:

• the company has high CAPEX (production, energy, infrastructure),
• “Beautiful EBITDA” goes hand in hand with poor cash flow,
• The company presents Adjusted EBITDA and eliminates costs too aggressively (“one-off” items each year).

Most common ratios with EBITDA

EV/EBITDA (EBITDA multiple)

Used in valuation: a lower multiple can mean a cheaper valuation (always in the context of the industry and risk).

Debt/EBITDA (debt to EBITDA)

It shows how many years it would take to pay off the debt if EBITDA were hypothetically used for repayments. The higher the value, the higher the risk.

FAQ: frequently asked questions about EBITDA

1) Is EBITDA the same as profit?

No. EBITDA is “before” interest, taxes, depreciation and amortization; net profit is after all expenses.

2) Why EBITDA is not cash flow?

Because it does not take into account CAPEX, working capital or debt repayment.

3) What is EV/EBITDA?

The ratio of enterprise value to EBITDA, used in comparing firm valuations.

4) Is higher EBITDA always good?

Not necessarily – CAPEX, debt, margins, earnings stability and cash flow are also critical.

5) What does “adjusted EBITDA” mean?

EBITDA adjusted for selected items. It is useful, but one needs to check what exactly the company has “cleaned up”.

Conclusion

EBITDA is a handy metric for quick comparison of operating performance and often serves as a basis for valuing companies (EV/EBITDA) or assessing debt (Debt/EBITDA). At the same time, it is not a measure of cash and can distort reality, particularly where there is a high level of investment in assets or where “adjusted” EBITDA is used. Therefore, always combine EBITDA with cash flow and other financial metrics to make a good decision.