EBITDA
$$\text{EBITDA} = \text{Net Income} + \text{Interest} + \text{Tax} + \text{D\&A}$$
What is EBITDA?
EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization) measures the cash profit generated by a company's core operations, stripped of financing decisions, accounting depreciation methods, and tax policies. By removing these four items from Net Income, EBITDA reveals how much operating cash flow the business generates on a comparable, policy-neutral basis.
The metric was popularised in the 1980s by leveraged buyout analysts who needed to assess how much debt a target company could service. Today it is the universal language of business valuation: investment bankers quote deals as multiples of EBITDA (e.g. "acquired at 8× EBITDA"), private equity firms measure portfolio company performance in EBITDA, and lenders set debt covenants relative to EBITDA (e.g. "net debt may not exceed 4× EBITDA").
EBITDA is calculated using the bottom-up method: start with Net Income and add back Interest Expense, Tax Expense, Depreciation, and Amortization. The top-down method starts with Revenue and subtracts only cash operating costs, arriving at the same figure.
When to use EBITDA
Use EBITDA when comparing the operating performance of companies with different capital structures, depreciation policies, or tax jurisdictions — or when estimating the debt capacity of a business. It is the standard metric for M&A valuation (EV/EBITDA multiple), leveraged buyout modelling, and bank covenant testing.
Worked examples
| Company | Net Income | + Interest | + Tax | + D&A | = EBITDA |
|---|---|---|---|---|---|
| SaaS startup | $1,200,000 | $50,000 | $400,000 | $150,000 | $1,800,000 |
| Manufacturer | $3,000,000 | $400,000 | $900,000 | $800,000 | $5,100,000 |
| Retailer | $500,000 | $100,000 | $170,000 | $230,000 | $1,000,000 |
| Restaurant group | $800,000 | $200,000 | $280,000 | $420,000 | $1,700,000 |
Common pitfalls
EBITDA is not cash flow. It ignores CapEx requirements (a capital-intensive business that needs heavy reinvestment is worth less than its EBITDA implies), changes in working capital (which can consume or release cash), and the quality of earnings. Always review free cash flow conversion (FCF / EBITDA) alongside EBITDA. EBITDA is also not a GAAP metric — companies can define it differently, so always compare like-for-like.
Frequently asked questions
Is EBITDA the same as operating cash flow?
No. EBITDA ignores changes in working capital and capital expenditures. A business with high EBITDA but rising accounts receivable and heavy CapEx may generate very little actual cash. Free cash flow (FCF = Operating Cash Flow − CapEx) is a more complete measure.
Why do acquirers use EBITDA for valuation?
Because it allows comparison across companies with different debt loads, tax rates, and depreciation policies. The EV/EBITDA multiple tells an acquirer how many years of current EBITDA they are paying for the entire business, on a capital-structure-neutral basis.
What is a normal EBITDA multiple?
It varies by industry and growth profile. SaaS companies trade at 10–25× EBITDA; traditional manufacturers at 5–8×; retail at 4–7×. High growth and high margins command premium multiples. Always use sector-specific comparable transactions.