I have heard this “EBITDA” buzzword thrown around a couple of times, and i had no freaking clue what it meant ? I shrugged it off thinking one of those trading terms i will never understand…Few days back i read it in some of the message boards and decided to have a look at it. Turns out its an acronym which means E
epreciation and A
mortization. Now that is pretty intuitive, isnt it ?
EBITDA = Revenue – Expenses (excluding interest, tax, depreciation and amortization)
EBITDA is used to analyze a company’s operating profitability before non-operating expenses (interest and tax) and non-cash charges (depreciation and amortization).
Pros of EBITDA
EBITDA is useful to analyse the overall profits between companies you are comparing without taking accounting decisions into consideration. Now this can be useful to compare companies based on how to they operate and how much profits they end up making. Sometimes its useful to evaluate different sectors/industry, because it removes the impact of financing large capital investments and depreciation from the analysis. (For example: EBITDA can be used to compare the profitability trends of automobile industry v/s high-tech industry.
Cons of EBITDA
EBITDA is a good metric to analyse profitability but not cash flow. Cash flow is a better measure of how much cash a company is generating because it includes non-cash charges (depreciation and amortization)
and non-operating expenses (interest and tax). Any investor should understand the cash flow and not rely solely on EBITDA otherwise they might miss out important clues.
Recommendation: EBITDA is a good measure to use to evaluate the core profit trends, but cash flow is much more important. EBITDA can be used to compare profits between companies but it should not replace the measure of cash flow. Do not ever ever ever make any investment based only on EBITDA. And remember that the next time someone throws EBITDA at you, you know what are they talking about.