What is EBITDA?
The Short Answer
EBITDA explained simply
EBITDA stands for Earnings Before Interest, Taxes, Depreciation, and Amortization. It's a way to look at a company's profit from its core operations. Think of it as the money a business makes before paying for things like interest on loans, taxes, and the cost of assets wearing out over time (depreciation and amortization).
We use EBITDA to get a clearer picture of a company's operational health. It strips away the effects of how a company is financed (debt vs. equity) and its accounting choices for assets. This makes it easier to compare the performance of different businesses, even if they have different debt levels or asset structures.
Real-World Example
The Coffee Shop Scenario
Let's say a coffee shop has the following:
- Revenue: $500,000
- Cost of Goods Sold (COGS): $150,000
- Operating Expenses (Rent, Salaries, Utilities): $100,000
- Interest Expense: $10,000
- Taxes: $20,000
- Depreciation: $5,000
- Amortization: $2,000
To calculate EBITDA:
- Gross Profit: Revenue - COGS = $500,000 - $150,000 = $350,000
- Operating Income (EBIT): Gross Profit - Operating Expenses = $350,000 - $100,000 = $250,000
- EBITDA: Operating Income + Depreciation + Amortization = $250,000 + $5,000 + $2,000 = $257,000
So, the coffee shop's EBITDA is $257,000. This shows its profit from operations before considering financing and non-cash charges.
Why this matters
EBITDA is important because it helps buyers and sellers understand a business's true operating profitability. It removes the impact of financing decisions and accounting methods, making it easier to compare businesses. This metric is often used in business valuations to determine a fair selling price.
EBITDA is a good starting point, but it doesn't tell the whole story. Always look at cash flow too, as EBITDA doesn't account for capital expenditures or changes in working capital.
EBITDA is a good starting point, but it doesn't tell the whole story. Always look at cash flow too, as EBITDA doesn't account for capital expenditures or changes in working capital.
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