EBITDA stands for Earnings Before Interest, Taxes, Depreciation, and Amortization. It approximates a company's core operating cash-generating ability by stripping out financing decisions, tax jurisdiction effects, and non-cash accounting charges.
Why It Matters
EBITDA is the most common denominator in M&A and private equity valuation — deals get priced as a multiple of EBITDA precisely because it lets buyers compare companies with different capital structures and depreciation schedules on a more apples-to-apples basis. It's also the metric most frequently used to set and test loan covenants.
How It Works in Practice
- 1Start with net income from the income statement
- 2Add back interest expense (removes the effect of how the company is financed)
- 3Add back taxes (removes jurisdiction and tax-strategy effects)
- 4Add back depreciation and amortization (removes non-cash charges tied to past capital spending)
- 5Adjusted EBITDA further add back one-time or non-recurring items — a common and frequently contested step in deal negotiations
Common Pitfalls
EBITDA excludes capital expenditure entirely, which can make capital-intensive businesses look far healthier than their actual cash generation supports
"Adjusted EBITDA" add-backs are negotiated, not standardized — aggressive add-backs are one of the most common sources of dispute in sell-side processes and post-close disputes
EBITDA is not a substitute for free cash flow; a profitable-looking EBITDA company can still be cash-flow negative after capex, working capital changes, and debt service