What is EBITDA?
EBITDA is the earnings a business has before interest, tax, depreciation, and amortization, and is an indicator of operational profitability of the business.
It is a sub total line in the profit and loss account as shown below.
|Cost of sales||45,000|
|Profit before tax||10,000|
Why is EBITDA Useful?
As the line is drawn before interest, depreciation and tax, the EBITDA effectively represents the profit of the business before the effects of any capital investment (depreciation), before the effects of its method of financing activities (interest), and before the effect of any localised tax rates.
For this reason, EBITDA can be used as an indicator to compare businesses which have similar business models, but which have different financing structures, depreciation policies and tax systems.
EBITDA is also a useful indicator of cash flow from business operations and is the starting point for cash flow statements.
A multiple of EBITDA is often used to support business valuations particularly when the business has net losses. For example is a business has EBITDA of 100,000 and the multiple for the type of industry it operates in is say 5, then an indication of the value of the business would be 5 x 100,000 = 500,000.
What EBITDA is not
EBITDA is not the same as cash flow. It is part of cash flow in that it represents the revenue after expenses, but it does not include cash required to fund working capital requirements (inventory, accounts receivable, and accounts payable), and to pay for capital expenditure, and such items as debt repayments.
About the Author
Chartered accountant Michael Brown is the founder and CEO of Double Entry Bookkeeping. He has worked as an accountant and consultant for more than 25 years in all types of industries. He has been the CFO or controller of both small and medium sized companies and has run small businesses of his own. He has been a manager and an auditor with Deloitte, a big 4 accountancy firm, and holds a BSc from Loughborough University.