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EBITDA

Definition

EBITDA - Earnings Before Interest, Taxes, Depreciation and Amortization. Investment bankers, private equity specialists and investment analysts may mention "EBITDA" as a method of valuing a company. It is fairly simple to calculate -- you take the Net Income of a company and then add back certain numbers from the income statement (these numbers a located just above the Net Income number on the income statement) Specifically, you take Net Income and add back interest, taxes, depreciation, and amortization. Like the price to earnings ratio, you may use EBITDA as a comparison metric between companies and industries. It is valuable in the fact that it eliminates the changes in net income that were made due to financing (use of leverage) and managerial accounting decisions. However, there are potential problems that stem from EBITDA as well . . .

Using the term EBITDA :

EBITDA may be abused as there is not a standard GAAP method of calculation, so management may change its methodology from time to time. You can also get into a cash flow problem by relying strictly on EBITDA since it does not address working capital requirements (or the cost of replacing old equipment).

Pay Special Attention To :

You must absolutely use EBITDA with other industry ratios when evaluating the investment worthiness of a company. If you look at EBITDA in isolation (like any financial ratio) you are asking for trouble. We would go so far as to say that if the valuation discussion for a company focuses only on EBITDA, then you must be very careful (and critical) in your evaluation.

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Related terms

Price to Earnings Ratio , Investment Analysis