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EBITDA Earnings Before Interest, Taxes, Depreciation and Amortization. An approximate measure of a company's operating cash flow based on data from the company's income statement. Calculated by looking at earnings before the deduction of interest expenses, taxes, depreciation, and amortization. This earnings measure is of particular interest in cases where companies have large amounts of fixed assets which are subject to heavy depreciation charges (such as manufacturing companies) or in the case where a company has a large amount of acquired intangible assets on its books and is thus subject to large amortization charges (such as a company that has purchased a brand or a company that has recently made a large acquisition). Since the distortionary accounting and financing effects on company earnings do not factor into EBITDA, it is a good way of comparing companies within and across industries. This measure is also of interest to a company's creditors, since EBITDA is essentially the income that a company has free for interest payments. In general, EBITDA is a useful measure only for large companies with significant assets, and/or for companies with a significant amount of debt financing. It is rarely a useful measure for evaluating a small company with no significant loans. Sometimes also called operational cash flow. _________________________________________________________________ Earnings Before Interest, Taxes, Depreciation, and Amortization - EBITDA An indicator of a company's financial performance calculated as: = Revenue - Expenses (excluding tax, interest, depreciation, and amortization) EBITDA can be used to analyze the profitability between companies and industries, because it eliminates the effects of financing and accounting decisions. A common misconception is that EBITDA represents cash earnings. EBITDA is good metric to evaluate profitability, but not cash flow. EBITDA first came into common use with leveraged buyouts in the 80s, where it was used to indicate the ability of a company to service debt. As time passed, it became popular in industries with expensive assets that had to be written down over long periods of time. Lately, EBITDA is commonly quoted by many industries, especially technology, even when it isn't warranted. Consequently, EBITDA is frequently being used as an accounting gimmick to dress up a company's earnings. ___________________________________ EBITDA: The Good, The Bad, and The Ugly EBITDA is one of those terms that is getting increased usage but usually for the wrong reason. This article will define it and discuss how it can be useful but also misleading. EBITDA is an abbreviation for "earnings before interest, taxes, depreciation and amortization." It is calculated by taking operating income and adding back to it interest, depreciation and amortization expenses. EBITDA is used to analyze a company's operating profitability before non-operating expenses (such as interest and "other" non-core expenses) and non-cash charges (depreciation and amortization). The Good EBITDA can be used to analyze the profitability between companies and industries. Because it eliminates the effects of financing and accounting decisions, EBITDA can provide a relatively good "apples-to-apples" comparison. For example, EBITDA as a percent of sales (the higher the ratio, the higher the profitability) can be used to find companies that are the most efficient operators in an industry. The ratio can also be used to evaluate different industry trends over time. Because it removes the impact of financing large capital investments and depreciation from the analysis, EBITDA can be used to compare the profitability trends of, say, "heavy" industries (like automobile manufacturers) to hi-tech companies. The new accounting rules that eliminate the amortization of goodwill, formally know as FAS 142, will bring operating income closer to EBITDA, but EBITDA will continue to be a better measure of core operating profitability. The Bad EBITDA is good metric to evaluate profitability but not cash flow. Unfortunately, however, EBITDA is often used as a measure of cash flow, which is a very dangerous and misleading thing to do because there is a significant difference between the two. Operating cash flow is a better measure of how much cash a company is generating because it adds non-cash charges (depreciation and amortization) back to net income and includes the changes in working capital that also use/provide cash (such as changes in receivables, payables and inventories). These working capital factors are the key to determining how much cash a company is generating. If investors do not include changes in working capital in their analysis and rely solely on EBITDA, they will miss clues that indicate whether or not a company is losing money because it cannot sell its products!
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