EBITDA

EBITDA describes what a business earns before financing choices, tax position and the way assets were written down. Its purpose is comparability.

Why it is used

Two identical companies can report very different profits because one bought its equipment and the other leases it, or because one carries a loan from a previous owner. Stripping out interest, tax and depreciation makes the operating performance comparable.

What it hides

EBITDA ignores the cash needed to replace assets and the cash tied up in stock. For a business that reinvests heavily, a healthy figure can coincide with an empty bank account.

• It is not cash flow
• It says nothing about working capital
• It can be inflated by capitalising costs that are really operating expenses

In owner-managed companies

Where the owner works in the business, EBITDA has to be read alongside the salary that owner takes. A minimal salary flatters the figure; a generous one depresses it. This is precisely why smaller transactions use discretionary earnings instead.