EBITDA Definition: EBITDA (earnings before interest, taxes, depreciation and amortisation) is a measure of company profit that adds back interest expense, income tax, depreciation and amortisation to net income. It shows how much a business earns from its operations before financing decisions, tax regimes and accounting charges for ageing assets. Because it removes those four items, EBITDA is often used to compare companies with very different debt levels and asset bases, but it is not a measure of cash.
What Is EBITDA?
Picture two pizza chains that sell the same number of pizzas at the same prices. One borrowed heavily to open its stores, the other paid cash. One sits in a high-tax country, the other in a low-tax one. Their bottom lines will look very different, even though the kitchens run equally well.
EBITDA tries to strip out those differences. It starts from net profit and adds back four costs that say more about financing, tax and accounting than about the daily business. Depreciation is the gradual write-down of physical assets such as ovens, trucks or servers. Amortisation does the same for intangible assets such as software licences, patents or customer lists acquired in a takeover.
John Malone, who ran the US cable company TCI in the 1970s and 1980s, is credited with popularising the measure. Cable networks were expensive to build, so depreciation and interest wiped out reported profit for years. Malone argued that lenders and investors should look at operating earnings before those charges, and the leveraged buyout boom of the 1980s turned EBITDA into the standard yardstick for how much debt a business could support.
How to Calculate EBITDA
Two routes lead to the same number. The bottom-up formula is: EBITDA = net income + interest + taxes + depreciation + amortisation. The top-down version starts from the income statement’s operating line: EBITDA = operating income + depreciation + amortisation. Both work because operating income already sits above interest and tax.
Take a hypothetical logistics company with $500 million in revenue. It reports net income of $40 million after paying $25 million in interest and $15 million in tax. Its trucks and warehouses carry $60 million of depreciation, and software it bought in an acquisition adds $10 million of amortisation.
Adding the four items back gives $40M + $25M + $15M + $60M + $10M = $150 million of EBITDA, a 30% EBITDA margin on revenue. A rival with no debt and newer, cheaper equipment might earn a higher net profit on the same operations. EBITDA puts both firms on the same line, so you can see that the gap comes from the balance sheet, not from how well each one runs its trucks.
Investors then use EBITDA in two ratios. EV/EBITDA divides enterprise value (market value of equity plus net debt) by EBITDA to show how many years of operating earnings the market is paying for. Net debt/EBITDA shows how many years of EBITDA it would take to repay borrowings, and lenders often write a ceiling for it into loan agreements.
EBITDA vs. Net Income
| EBITDA | Net Income | |
|---|---|---|
| Interest expense | Added back | Deducted |
| Income tax | Added back | Deducted |
| Depreciation and amortisation | Added back | Deducted |
| Accounting status | Non-GAAP, company-defined | Defined by GAAP and IFRS |
| Main use | Comparing operations, debt capacity, takeover pricing | Earnings per share, P/E ratio, dividends |
Net income is what is left for shareholders and feeds directly into earnings per share (EPS). EBITDA sits much higher up and belongs to every provider of capital, lenders included.
Why Is EBITDA Important for Traders?
EBITDA lets you value companies that report losses or carry large debts, where the P/E ratio breaks down. Telecoms, utilities, cable operators and private-equity-owned businesses are routinely priced on EV/EBITDA multiples. When an acquirer bids “10 times EBITDA”, that multiple is the language of the deal, and the share price of a target moves toward it.
Its main weakness is that depreciation is not imaginary. A trucking firm must eventually replace its trucks, so ignoring depreciation flatters businesses that need constant reinvestment. Warren Buffett has mocked the measure for decades, asking whether management thinks someone else pays for capital spending. The honest check is to compare EBITDA with cash flow after capital expenditure: when the two drift apart for years, the EBITDA story is hiding a cost.
A second risk is that companies define EBITDA themselves, and “adjusted EBITDA” can remove almost anything. WorldCom booked about $3.8 billion of ordinary network costs as capital spending, which took them out of operating costs and inflated EBITDA until the fraud came out in 2002. In 2018 WeWork showed bond investors a “community-adjusted EBITDA” that turned a 2017 net loss of more than $900 million into a profit by excluding building and growth costs. Each extra adjustment is a reason to read the reconciliation table in the filing.
Key Takeaways
- EBITDA adds interest, taxes, depreciation and amortisation back to net income to show earnings from operations before financing, tax and asset charges.
- It can be calculated bottom-up from net income or top-down by adding depreciation and amortisation to operating income.
- EV/EBITDA and net debt/EBITDA are standard tools for valuing indebted or loss-making companies and for setting loan covenants.
- EBITDA is not cash: it ignores capital spending, working capital and actual interest and tax payments, so it flatters capital-hungry businesses.
- Because no accounting standard defines it, “adjusted” EBITDA figures need to be checked against the reconciliation to net income.
Is EBITDA the same as cash flow?
No. EBITDA ignores changes in working capital, cash taxes, interest payments and capital expenditure, so a company can report rising EBITDA while its bank balance shrinks.
Why do banks use EBITDA in loan covenants?
Lenders want a measure of earning power that is not distorted by the borrower's existing debt or depreciation policy. A covenant such as net debt below 4x EBITDA lets them spot a borrower that is taking on more debt than its operations can carry.
Can EBITDA be negative?
Yes. Negative EBITDA means the business loses money even before interest, taxes and asset write-downs, which usually signals an early-stage company or a core operation that does not cover its own running costs.
Is EBITDA allowed under GAAP or IFRS?
Neither standard defines it, so EBITDA is a non-GAAP measure. US-listed companies may report it, but SEC rules require them to reconcile it to net income and not present it more prominently than the GAAP figure.
