Definition: Earnings before Interest, Taxes, Depreciation, and Amortization, or EBITDA, is a financial metric that measures a firm’s operating profitability.
What Does EBITDA Mean?
What is the definition of EBITDA? This metric is a measure of a company’s profitability and strength of operations. In effect, it shows how much cash flow a company generates from its operations. Many investors use this calculation to analyze a company without examining the company’s financing costs, tax burden, and accounting treatments.
Since this metric is not a ratio, it’s not used to compare companies of different sizes directly. Also, each company may different greatly from one another when the outside factors are considered.
If a company’s EBITDA is negative, it means the business is not profitable even without counting depreciation, amortization, and interest. In other words, it’s in bad shape.
When comparing two businesses, there will be characteristics and circumstances that make one business distinct from the other. This may have significant impacts on the financial health and appearance of a company to investors. EBITDA essentially allows a business to evaluate its earning on the basis of sales minus cash costs of operating.
Let’s look at an example.
Example
If two companies are being compared and one was formed during a recession and one was formed during an expansion, their interest rates and payments may differ. During the recession Company G may have incurred large amounts of debt in order to withstand the changes and behavior during the recession, which would eat at the business’s profits.
Company W was formed during a rise in the economy and experienced low interest rates and lower taxes. Even if both companies theoretically earned the same amount, Company G would appear less successful because of the tax responsibility and interest.
On the other hand, if Company W had a large amount of equipment, it might take advantage of heavy depreciation making it look less successful than Company G.
EBITDA fixes both of these problems by only looking at the core operations of the company without regard to interest, taxes, or paper expenses.
Summary Definition
Define EBITDA: Earnings before Interest, Taxes, Depreciation, and Amortization means a measurement of a company’s operating profits without regard to paper expenses, taxes, and interest.
