Level 6 · Financial Analysis
EBITDA
Useful for comparing businesses, dangerous when treated as cash.
In this lesson
What you'll be able to do
- Expand and explain EBITDA
- Know why analysts use it
- Understand its three big limitations
- Calculate EBITDA margin
Think about it
Why would anyone deliberately ignore interest, tax and depreciation when measuring profit?
Story
Let's picture it
Two identical factories produce the same goods with the same costs. One was bought with a big loan, the other with the owner's own money. Their net profits look completely different because of interest. Strip out interest, tax and depreciation and you can finally compare the factories themselves rather than how they were financed.
Visual
Building EBITDA
Net profit
Start at the bottom line
+ Tax
Different tax situations shouldn't distort the comparison
+ Interest
Removes the effect of how the company is financed
+ Depreciation & amortisation
Non-cash accounting charges
= EBITDA
Operating performance, comparably measured
Plain English
The simple explanation
EBITDA stands for Earnings Before Interest, Tax, Depreciation and Amortisation. It approximates operating performance while ignoring financing choices and accounting charges.
It is popular because it lets you compare two companies in the same industry regardless of their debt levels, tax positions or asset ages.
The danger is treating EBITDA as cash. Depreciation exists because machines wear out and must eventually be replaced. Interest is a real payment. Tax is a real payment. A company can post rising EBITDA and still run out of money.
Real world
Telecom and infrastructure
Capital-heavy sectors like telecom quote EBITDA constantly because their depreciation is enormous. It is a fair comparison tool for them, but their actual cash position depends heavily on interest and capital expenditure, which EBITDA hides.
Watch out
Common mistakes
- Treating EBITDA as available cash.
- Comparing EBITDA across unrelated industries.
- Celebrating EBITDA growth while free cash flow stays negative.
Did you know?
Charlie Munger once described EBITDA as 'bullshit earnings', a blunt reminder that ignoring depreciation ignores the cost of keeping a business running.
Your turn
Mini challenge
Pick a capital-heavy company. Compare its EBITDA with its cash flow from operations for three years. How wide is the gap?
Quick quiz
1 / 5
Wrap up
Summary
EBITDA compares operating performance across companies with different financing and asset ages, but it is not cash, and the gap between EBITDA and cash flow is where the real story lives.
- EBITDA = operating profit + depreciation + amortisation
- Great for like-for-like comparison
- Never treat it as cash
- Always check EBITDA against operating cash flow
Revise