EBITDA

EBITDA stands for earnings before interest, taxes, depreciation, and amortisation. It measures a company's operating earnings power, independent of financing and accounting effects such as depreciation and amortisation. That is why it is often used to compare the profitability of different companies. It is usually calculated as net income plus taxes, net interest and depreciation and amortisation of tangible and intangible assets, or directly from EBIT plus depreciation and amortisation.

The advantage is comparability: differences in interest expense, income taxes and depreciation are removed. Lease accounting can still affect EBITDA, so purchased and leased assets are not automatically comparable. Adjustments and the classification of individual income and expense items must also be transparent. The familiar criticism is that it excludes precisely the costs that reflect a business's capital intensity: ignoring depreciation ignores the fact that machinery must be replaced, so high EBITDA alongside heavy investment needs says little about cash actually available. For that reason cash conversion and the capital expenditure ratio are always shown alongside it in practice.

Despite this limitation EBITDA is the central reference in transaction practice, because purchase prices are set as multiples of it and debt limits are measured against it. The figure used is almost always an adjusted EBITDA for the last twelve months. It is worth noting in practice that high EBITDA combined with weak cash flow regularly has three causes: growing working capital, heavy replacement investment, or income unmatched by cash. The causes need separate assessment. Additional working capital can support growth but also threaten liquidity, while replacement investment indicates ongoing capital requirements. Diligence therefore examines reconciliations from EBITDA to operating and free cash flow over several years.