EBITDA is one of those acronyms that often appears in the accounts and narrative supposed to explain the financial outcomes of an enterprise. The meaning is often unclear to those unfamiliar with accounting jargon.
It stands for: Earnings Before Interest, Taxes, Depreciation, and Amortisation.
It is always a number near the bottom of the profit and loss statement, often confusingly also called the Income Statement.
Earnings. This appears at the bottom of the income statement, often called net profit. It reflects the outcome of all trading activity of the business. Sales revenue, minus the costs of doing business.
Before: Before, is before…. Who would have guessed? The items that follow are non-trading items that nevertheless impact on the cash of the business. They are all items that are further deductions from what the owners of the business will see in their pockets, but not directly attributable to trading activity.
Interest: We all know what interest is, we borrow money, and the cost of that borrowing is the interest we pay to the lender. A business is no different, it borrows money, it pays interest. However, the source of the funds used to operate the business has no impact on the trading activities, and is therefore excluded from the trading results.
Tax. When you make a profit, you pay tax. Simple, unless you are a multinational with a head office somewhere tropical. However, the payment of tax on profit has no impact on the operations of the business, so has also been excluded.
Depreciation. Assets wear out with use and need to be replaced from time to time. Including a number reflecting the depreciation of assets is again a non-cash item that has no impact on the trading activity, but can have a very big impact on the cash flow when assets are replaced.
Amortisation. This is similar to depreciation but applies to intangible assets. Assume the business purchased a competitor, paying an amount above the net asset value of the purchased business, but whose trading results are included in the numbers. You may want to write down that nominal overpayment over time to bring the value of the business, as reflected in the balance sheet back to closer to the net realisable asset value of the combined businesses.
The benefit of an EBITDA number is that it enables comparisons over time, and between businesses, even across industries. The downside is that there is no regulated formula for calculating it, there is discretion allowed, so beware of the weight you put on the final EBITDA number.
Header credit: Scott Adams and Dilbert, never confused by a good acronym.
