EBITDA is an indication of the total earnings of a business in a given fiscal year without taking into consideration interest, taxes, depreciation, and amortization. This is a quantitative value that represents the financial health of a company taking into account its revenues and cost of sales without considering its balance sheet. Here is a simple breakdown of what EBITDA tells us:
Earnings – This involves the overall profits, or gains of the business, in other words, the company’s net income from the operations.
Interest – Here refers to the amount of interest that the company incurs as a result of its borrowings. Interest is another expense subtracted from net income because it represents the cost of using borrowed funds in the business rather than the result of standard operations.
Taxes – Similar to interest, taxes are a cost which can be affected by state regulation and thus should be subtracted. Taxes are not directly a part of or directly associated with the company business processes or activities.
Depreciation- this is an accounting process that involves spreading the cost of an asset over its useful life, typically machinery and equipment. This implies that the aim of deducting depreciation is to ascertain the income generating capability of such assets while they are still useful to the business.
Amortization – This is like depreciation but is related to the costs of intangible assets and the assumption that they are used over time. Some of the well-known instances are patents and copyrights.
However, EBITDA shows the profitability of the key business activities of an enterprise based on the net profit, but without taking into consideration such factors as interest costs or tax consequences. It puts in the disposal of investors a measure against which they can use to measure and compare the level of profitability of various companies within the same industry.
Hence for most analysts, EBITDA while not giving a full picture of the state of affairs is an easy way to understand the operating cash flow generation capacity of a business. EBITDA is valuable for such uses as when comparing investments or as a measure of the capability of paying off debts over time.