What is EBITDA? Earnings before interest, tax, depreciation and amortisation
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EBITDA stands for earnings before interest, tax, depreciation and amortisation. Starting from net income, add back interest, tax, depreciation and amortisation. Starting from operating profit (EBIT), which is already before interest and tax, add back depreciation and amortisation only. This comparison strips out some financing, tax and accounting effects, but EBITDA is not the same as cash.
What the four letters add back
Start with net income: add back interest, income tax, depreciation and amortisation to reach EBITDA in this simplified example. Alternatively, start with operating profit (EBIT), which already excludes interest and tax, and add back depreciation and amortisation only. Interest reflects financing, tax reflects the tax position, and depreciation and amortisation allocate historical asset costs over time.
Depreciation and amortisation are non-cash in the period: the cash often went out years earlier when the asset was bought. Removing all four is meant to isolate the operating result, so a buyer can compare two companies without the noise of different debt loads, tax positions and accounting for old spending. EBITDA is a non-GAAP measure, so there is no single legally defined formula; companies must reconcile it to a standard figure.
A worked example: from £100m revenue to EBITDA
Imagine a company with £100m of revenue. Its operating costs, excluding depreciation and amortisation, are £65m. That leaves EBITDA of £35m. These figures are illustrative, chosen to show the mechanism rather than describe a real company.
EBITDA is not the end of the income statement. Subtract £10m of depreciation and amortisation to reach operating profit of £25m, then £5m of interest and £6m of tax, and net income is £14m. The same £35m of EBITDA could sit above very different net incomes depending on debt, tax and how asset-heavy the business is.
Revenue minus operating costs, before D&A, interest and tax.
Only after EBITDA, to reach net income:
Why buyers and investors quote it
Because EBITDA strips out financing and tax, it lets you compare the underlying operations of businesses with different capital structures. Two firms running the same operation can report the same EBITDA even if one carries debt and the other does not, as the table shows.
That is why acquisitions are often quoted as a multiple of EBITDA, such as an enterprise value of eight times EBITDA. In a leveraged buyout, the multiple paid and the EBITDA the business can grow are central to the return. The multiple is a shorthand, not a valuation on its own: it depends on growth, risk and how much cash the EBITDA actually becomes.
| Line | Firm A (no debt) | Firm B (debt-financed) |
|---|---|---|
| EBITDA | 35 | 35 |
| Depreciation & amortisation | 10 | 10 |
| Operating profit (EBIT) | 25 | 25 |
| Interest | 0 | 8 |
| Profit before tax | 25 | 17 |
Misconception: EBITDA is cash flow
EBITDA ignores three real cash costs. It adds back depreciation but ignores the capital expenditure needed to replace the very assets that were depreciating. It ignores changes in working capital, the cash tied up in inventory and receivables as a business grows. And it is stated before interest and tax, which most companies must actually pay.
For a capital-intensive business, EBITDA can therefore sit well above the cash left for owners and lenders. Berkshire Hathaway's shareholder letters make this criticism bluntly: treating depreciation as a non-expense assumes assets never need replacing. Use EBITDA to compare operations, then look at free cash flow to judge how much money the business keeps.
Check your understanding
Optional: apply the idea to a new scenario.
Two companies both report EBITDA of £35m. One is a software firm with light ongoing capital spending; the other runs a fleet of vehicles that must be replaced regularly. With the same EBITDA, why might the cash available to their owners differ, and what would you check?
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