What is EBITDA?

‍
EBITDA stands for Earnings Before Interest, Taxes, Depreciation, and
Amortisation. It’s a financial metric that is used to assess a company’s
operating performance. Essentially, EBITDA strips out non-operational
expenses, giving a clearer picture of the company’s core profitability. This
makes it a valuable tool for investors, lenders, and business owners who
want to focus on how well a business is generating profit from its core
operations, without being influenced by its financing and accounting
decisions.

‍
To calculate EBITDA, you start with the company’s net income and then
add back interest, taxes, depreciation, and amortisation. The formula
looks like this: EBITDA = Net Income + Interest + Taxes + Depreciation +Amortisation

‍
The reason EBITDA is so popular is that it’s simple to calculate and
provides a snapshot of profitability that is comparable across different
companies, industries, or time periods. However, it's essential to
remember that EBITDA does not account for the cost of capital
investments or changes in working capital, which may be critical for
certain business evaluations.

‍
Why is EBITDA Used to Value Businesses?

‍
EBITDA is widely used in business valuations because it helps investors or
potential buyers understand how profitable a company is on a
fundamental level. By stripping out non-operational expenses, EBITDA
allows for a comparison between companies regardless of their capital
structure (i.e., how much debt or equity they use), tax regime, or
accounting methods.

‍
When a company is up for sale, buyers are interested in how much cash
the business can generate from its operations, as this is a key factor in
determining its value. Since EBITDA focuses purely on operating
profitability, it can serve as a baseline for understanding the business's
earnings power. It also helps smooth out differences between companies
that might have varying levels of debt or tax situations.

‍
In essence, EBITDA provides a more uniform benchmark for comparing
businesses, which is why it’s so frequently used in mergers and
acquisitions (M&A), investor analysis, and financial projections. However,
because EBITDA doesn’t account for capital expenditures or interest costs,
it’s often used in conjunction with other metrics like net income or free
cash flow to provide a more comprehensive view of a company’s financial
health.

‍