EBITDA is earnings before interest, taxes, depreciation, and amortization. EBITDA serves as an indicator of financial performance and comparative metric. EBITDA is a non-GAAP metric (GAAP = generally accepted accounting principles), partially because it is not calculated in a defined way for all companies.

EBITDA = Revenue - Expenses (not including taxes, interest, depreciation, and amortization)

EBITDA can be helpful because some companies may have a lot of debt or complicated taxes (due to acquisitions, etc.) that make comparing them to others difficult. By removing these variables from the equation, you have a standardized metric. However, EBITDA is not cash flow. 

Taxes and interest rate costs are real, tangible, things that cost companies a lot of money. Excluding them can be valuable for comparative purposes, but in order to make any decisions based on cash flow a different accounting measure should be used. Using EBITDA to evaluate cash flow would be like saying "Well, I have $10,000 cash to invest, but first I have to pay my taxes (20%) and my $3,000 mortgage payment." If your "net" amount doesn't include some expenses, it isn't a true "net" measure! 

Excluding depreciation especially allows comparison of companies across industries - a telecomm company will have to spend much more money replacing infrastructure and other capital than an internet company like Google, so removing these expenses from the equation allows a clear comparison. Depreciation and amortization may not be tangible costs in the short-term, but capital does have to be replaced eventually, and factoring this into one's accounting measures ensures there won't be an unpleasant surprise when that time comes. Additionally, companies can calculate EBITDA in whatever way they see fit (because it is not GAAP), meaning this is not an entirely reliable number and can be used to paint a nicer picture of ones' finances. 

EBITDA is often used in loan agreements or in evaluating leverage ratios. If a company has an EBITDA of $20 mil and is looking at a $10 mil dollar loan, they will have .5x leverage* and be likely to pay this off. However, say the company already has outstanding debt and has a lot of taxes. Their actual revenue - expenses might be $5 mil, and suddenly this company has 2x leverage. 

Therefore, any individual trying to evaluate a company would be wise to look at many other metrics besides EBITDA. 

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*leverage being debt/EBITDA or debt/net revenue

AuthorIsabel Munson