EBITDA stands for Earnings Before Interest, Taxes, Depreciation and Amortization, and is used as a ballpark figure for where the company’s earnings are without these expenses.
It gives a picture of the total operating revenue of a company with the expenses that are related to financing decision and the tax environment left out. Accountants can calculate EBITDA by taking net income (earnings, or operational earnings) and adding interest payments, tax obligation, depreciation of hard assets, and amortization of intangibles back into it.
This gives a picture of the earnings of a company before the consideration of any financing decisions or taxation, since these can both change without having much correlation with the company’s ability to generate revenue.
Because this is a non-GAAP method, investors should not necessarily take this number at face value, but it can be used as another way to compare companies to one another, since they may have different sorts of taxes applied to them and whatnot.
Analysts and accountants will use this technique sometimes, however, to see how strong a company’s revenue stream is in relation to it operating expenses, which are not added back in. A popular use of EBITDA is in the EV/EBITDA ratio, where EV is the Enterprise Value.
Enterprise value is arrived at after an involved calculation which factors in both forms of market cap (equity and debt) as well as minority interest in other companies and so on, which ends up being about the amount that an acquiring company would have to pay to own 100% of the company.
By dividing that value by EBITDA, or by instead using the reciprocal value of EBITDA/EV, a valuation of cash flow relative to the total value of the business can be made in a way that can be compared to other companies or a benchmark created from averaging the results from other similar companies.
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