What is EBITDA?

What is EBITDA for?

It answers the question 'how well does the business trade, before how it is financed and how it accounts for its assets?' Interest depends on how much you borrowed; tax depends on the rules and your structure; depreciation depends on estimates you made. Take those out and what remains is closer to the cash the trade itself generates.

That makes it useful for comparing businesses with different debt, different asset bases or different tax positions, and it is the figure buyers and lenders most often start from when valuing a small business, usually as a multiple.

It is not profit, and it is not cash flow. A business can have healthy EBITDA and still be unable to service its loans, replace its vans or pay its tax, because those are precisely the things EBITDA leaves out. It is a measure of the engine, not of whether the car will get you home.

A worked example

A small engineering firm's profit and loss for the year shows turnover of £180,000, staff, rent, materials and other running costs of £130,000, depreciation on its machines of £6,000, and loan interest of £2,000. Profit before tax is £42,000.

EBITDA adds back the interest and the depreciation: £42,000 plus £2,000 plus £6,000 is £50,000. Tax has not been deducted yet, so there is nothing to add for it. There is no amortisation because the firm has no intangible assets.

A buyer looking at the firm sees £50,000 of underlying earnings and applies whatever multiple the market supports. The owner, meanwhile, knows the £50,000 has to cover the loan repayments, the tax bill, and the next machine.

How is EBITDA different from net profit?