What Is EBITDA? Key Financial Metric You Need To Know To Do Business

EBITDA serves as a modified form of operating income by excluding non-operating and non-cash expenses

EBITDA, short for Earnings Before Interest, Taxes, Depreciation, and Amortisation, is a metric used to evaluate a company's operational efficiency. It provides an approximation of the cash flow generated by its overall business activities. In the current and previous seasons of Shark Tank India, the judges repeatedly used this term to evaluate the performance of the businesses that come to pitch on the show.

What Is EBITDA

EBITDA serves as a modified form of operating income by excluding non-operating and non-cash expenses. This adjustment helps eliminate factors such as capital structure, depreciation methods, debt financing, and taxes (to some extent) over which business owners have control. Doing so provides a clearer picture of a company's financial performance, independent of its capital structure.

EBITDA concentrates on a company's operational decisions by evaluating the profitability of its core activities before factoring in elements like capital structure, leverage, and non-cash expenses such as depreciation.

It's worth noting that EBITDA is not a recognised metric under International Financial Reporting Standards (IFRS) or US Generally Accepted Accounting Principles (GAAP). Some investors, like Warren Buffet, criticise this metric for its failure to consider asset depreciation. For instance, if a company possesses significant depreciable assets (leading to substantial depreciation expenses), the actual cost of maintaining and supporting these capital assets remains unaccounted for.

Formula To Calculate EBIDTA

EBITDA is equal to the sum of a business’s operating profit, depreciation and amortisation (EBITDA = Operating Profit + Depreciation and Amortization).

Why EBIDTA Is Used

EBITDA is often regarded as a proxy for cash flow. By multiplying EBITDA by a valuation multiple obtained from industry transactions, stock research reports, or M&A activities, analysts can quickly estimate the company's value and determine a valuation range.

Moreover, investors may utilise EBITDA to evaluate a company's performance, especially if the company is not profitable. This metric is commonly employed by private equity firms as it facilitates comparisons among similar businesses within the same sector. Additionally, business owners utilise it to benchmark their performance against competitors.