What is EBITDA?



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EBITDA stands for earnings before interest, tax, depreciation and amortization. To arrive with the EBITDA you take revenue, you subtract cost of goods sold, you get gross margin. From gross margin if you subtract operating expenses, you get what is called EBIT. To this EBIT you have to add back depreciation and amortization to get EBITDA. The number of EBITDA is very popularly used among financial analysts to measure the core health of the core operations of the company.

The number EBITDA is very close to the cash flow of the company. It basically indicates how much profits the company makes after the revenue has been used to pay down all operating expenses that are relevant to the day to day functioning of the company. Typically to get to the free cash flow number analysts take the EBITDA number and they subtract CAPEX and sometimes change in working capital to get to free cash flow. So EBITDA minus Capital Expenditure minus change in working capital is equal to the free cash flow number.

So, a positive EBITDA indicates that a company operations are being run efficiently and the company has a lot of cash left over, in case it needs to raise new money and pay interest, etc. A negative EBITDA indicates that the company is unprofitable, poorly run or inefficient, hence, will not be able to borrow more money and hence pay interest.

Another role that EBITDA plays is that an EBITDA multiple is very popularly used in valuation. When you value a company, using comparable trading or comparable acquisitions you will typically compare your company to another company using a EBITDA multiple. The EBITDA multiple is nothing but the equity value of the company divided by the EBITDA of the company. This indicates for example, the equity value of the company is 100 million dollars, and the EBITDA of the company is $10 million, so the EBITDA multiple is 100/10 which is 10X. This indicates that the company is valued at 10 times of EBITDA multiple. Hence, EBITDA is used by financial analysts both as an operation efficiently measurement tool as well as a valuation metric.

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