EBITDA

Knowledge Center

Earnings Before Interest, Taxes, Depreciation and Amortization. Explanation EBITDA.

Contents

  1. Summary
  2. Forum
  3. Expert Tips
  4. Resources

  Print





What is 12manage?
Log in

What is EBITDA? Description

EBITDA stands for earnings before interest, taxes, depreciation, and amortization. EBITDA came into wide use among private capital firms, wanting to calculate what they should pay for a business.


Calculation of EBITDA. Formula


      Net Sales

-     Operating Expenses

------------------------------------------------------

      Operating Profit (EBIT)

+    Depreciation Expenses

+    Amortization Expenses

------------------------------------------------------

      EBITDA


Using EBITDA

The private capital firms that originally employed EBITDA as a useful valuation tool removed interest, taxes, depreciation, and amortization from their earnings calculations in order to replace them with their own presumably more precise numbers:

  • They removed Taxes and Interest because they wanted to substitute their own tax-rate calculations and the financing costs they expected under a new capital structure.
  • Amortization was excluded because it measured the cost of intangible assets acquired in some earlier period, including goodwill, rather than any current expenditure of cash.
  • Depreciation, an indirect and backward-looking measure of capital expenditure, was excluded and replaced with an estimate of future capital expenditure.

Later, many public companies, analysts and journalists have urged investors to also use EBITDA to measure the cash which public companies generate. EBITDA is often compared with cash flow, because it rightfully adds back to net income two major expense categories that have no impact on cash: depreciation and amortization.


Why EBITDA can be misleading

Yet EBITDA is a very poor and even misleading mechanism if it is used to approximate cash flows of public companies! Why?

  1. It excludes taxes and interest, which are real cash items and not at all optional. A company must of course pay its taxes and loans.
  2. It does not exclude all non-cash items. Only depreciation and amortization are excluded. Among the non-cash items not adjusted for in EBITDA are bad-debt allowances, inventory write-downs, and the cost of stock options granted.
  3. Unlike proper measurements of cash flow, EBITDA ignores changes in working capital. Additional investments in working capital consume cash.
  4. Finally, the main flaw of EBITDA is in the E (Earnings). If a public company has over- or under-reserved for warranty costs, or for restructuring expenses, or for bad-debt allowances, its earnings will be skewed. Its EBITDA will be misleading. If it has recognized revenue prematurely or disguised ordinary costs as capital investments, its reports are suspect. If it has inflated revenue through round-trip asset trades, the E is of no informational value.

Book: Steven M. Bragg - Business Ratios and Formulas : A Comprehensive Guide -

Book: Ciaran Walsh - Key Management Ratios -




Earnings Before Interest, Taxes, Depreciation and Amortizati Forum (5 topics) Help

To get access to this forum, you need to be a member! Register (30 seconds)  |  Log in

  Calculate the EBITDA on a US GAAP basis      
  The meaning of the A in EBITDA      
  EBITDA helps in merger and acquisition      
  EBITDA for Aluminium Manufacturer      
  EBITDA growing in Europe      



Earnings Before Interest, Taxes, Depreciation and Amortizati Special Interest Group


Special Interest Group

Earnings Before Interest, Taxes, Depreciation and Amortizati Education & Events


Find Trainings, Seminars and Events


Compare with EBITDA:  EBIT  |  P/E Ratio  |  PEG Ratio  |  Relative Value of Growth  |  Economic Value Added  |  Economic Margin  |  Cash Ratio  |  Current Ratio  |  Earnings Per Share  |  Return on Equity  |  Return on Invested Capital  |  Market Value Added  |  CFROI  |  Fair Value  |  TSR  |  Seven Signs Of Ethical Collapse


Return to Management Hub: Decision-making & Valuation  |  Finance & Investing


More Management Methods, Models and Theory

Sponsor
Is your firm specialized in EBITDA?

Special Interest Group Leader
Would you like to be our EBITDA SIG Leader?

All you need to know about management

12manage for:



Management Smart Card

12manage in:





Copyright 2014 12manage - The Executive Fast Track. V12.0 - Last updated: 16-4-2014. All names tm by their owners.