EBITDA

A company takes in money and spends money. What’s left over at the end is the profit. But from this profit, things are deducted that have little to do with the actual business: interest on loans, taxes to the state, and the calculated loss in value of machinery, buildings, or software. EBITDA is the profit before exactly these four items are deducted. The five letters stand for the English terms for these items: Earnings Before Interest, Taxes, Depreciation and Amortization. The idea behind it: you want to see how much the core business itself generates, independent of debt, tax rate, and past investments.

Why investors like to look at it so much

Two companies can run exactly the same business and still report completely different profits. One built its factory with an expensive loan and pays high interest. The other belongs to a wealthy owner and is debt-free. One is based in Ireland with low taxes, the other in Germany. EBITDA filters out these differences and makes the two comparable.

The metric is especially important for young technology companies. A data center operator initially pours billions into servers and buildings. These expenditures are booked as loss in value over many years and push the reported profit deep into negative territory. The company can still be operationally profitable. That is exactly what EBITDA is meant to show.

Often it’s not the absolute figure that’s mentioned, but the EBITDA margin. This is the share of EBITDA in revenue. A software company with a 40 percent margin is considered very profitable, while a supermarket tends to sit around 5 percent. Loan agreements are also often tied to this figure: banks, for example, may allow debt of at most four times EBITDA.

How the figure comes about

You start with net profit, i.e., the amount right at the bottom of the income statement. Then you add back the four excluded items. First the interest paid, then the taxes, then the depreciation on tangible things like machinery, and finally the amortization on intangible things like patents or trademarks. The result is EBITDA.

A numerical example: A company reports 10 million euros in net profit. It paid 5 million in interest, 3 million in taxes, and depreciated 12 million. The EBITDA then amounts to 30 million euros. The figure sounds three times as good as the real profit, even though nothing has changed about the business.

This is exactly where the biggest trap lies. EBITDA is not an official metric under accounting rules, but a voluntary disclosure. Every company is allowed to calculate it itself. Many publish an adjusted EBITDA and additionally strip out restructuring costs, legal fees, or stock-based compensation to employees. Investor Warren Buffett mocks that depreciation is indeed a real cost: machinery wears down and must eventually be replaced.

EBITDA in quarterly results and acquisitions

Anyone reading business news stumbles across the term especially during earnings season. Corporations like SAP, Siemens, or Delivery Hero usually feature their EBITDA more prominently than their net profit. When a stock falls after good numbers, it’s often because EBITDA rose but the full-year forecast was lowered.

The metric is also the standard benchmark in company acquisitions. The purchase price is often quoted as a multiple of EBITDA, say eightfold. This is how a startup that isn’t yet making a profit can be valued in the first place. In negotiations, buyers and sellers therefore argue fiercely over which costs count as one-off and can be stripped out.

A practical tip for reading such reports: always compare EBITDA with the actual net profit and free cash flow, i.e., the money that actually ends up in the bank account. If these figures diverge widely on a sustained basis, a closer look is worthwhile. At companies like WeWork, the reported EBITDA was positive for years while the company was burning through enormous sums.