Financial Glossary
EBITDA
EBITDA -- Earnings Before Interest, Taxes, Depreciation, and Amortization -- measures operating profitability by stripping out financing costs, tax jurisdiction effects, and non-cash accounting charges. The formula is: EBITDA = Net Income + Interest Expense + Tax Expense + Depreciation + Amortization. Because it removes variables that differ across capital structures and tax regimes, EBITDA enables apples-to-apples comparisons of operating performance across companies and is a common basis for valuation multiples in M&A transactions. Adjusted EBITDA further removes one-time or non-recurring items to reflect normalized earning power.
Problem & Application
Two campground operators each generate $500,000 in net income. Operator A financed its land with a mortgage carrying $120,000 in annual interest; Operator B owns its land outright. Operator A also depreciates a recently-built bath house at $40,000 per year. Their reported net incomes look equivalent, but EBITDA tells a different story: Operator A's EBITDA is $660,000 ($500K + $120K interest + $40K depreciation), while Operator B's EBITDA is $500,000. A buyer evaluating both at 5x EBITDA would value Operator A's operations 32% higher, reflecting its stronger underlying cash-generating capacity before debt service. This is why lenders and acquirers use EBITDA -- not net income -- as their primary profitability benchmark.
In Short
EBITDA is useful for performance evaluation but should be analyzed alongside cash flow metrics for a complete financial picture.