EBITDA stands for earnings before interest, taxes, depreciation & amortization and is perhaps the most widely used metric to gauge a company’s performance. EBITDA is a Non GAAP metric which means that it is not mandatory for companies to report EBITDA as per their regular reporting requirements. In spite of that, EBITDA is widely reported by companies and tracked by Wall Street analysts and others across the business world. EBITDA first came into being during the LBO boom in the mid 1980’s as a metric to assess a company’s ability to service debt and has grown in popularity since.
So why is EBITDA so popular and widely used? For starters it is easy to understand and interpret. EBITDA is before interest which means that it removes the impact of how a company is financed. Companies have some flexibility with how they choose to depreciate a particular asset. If two companies in the same industry have different depreciation policies, then comparing them below EBITDA may distort the true picture. EBITDA is also before taxes and taxes are impacted by a company’s operating history and whether it has accumulated losses from prior periods.
By stripping out the impacts of differences in capital structure, depreciation policies and taxes across companies, EBITDA creates a level playing field and allows for a meaningful comparison across peers.
It is worth adding that the main reason behind its popularity is that it shows higher profits than would otherwise be reflected. EBITDA is already the metric of choice in industries with high debt and capital expenditure levels such as oil and gas, telecoms and infrastructure among others. Today, it is frequently used even in industries that do not have high capex or debt levels such as technology.
For all it’s popularity, it is important to tread with caution when dealing with EBITDA. There is no consistency in how EBITDA is reported across companies and industries. Given that it is such a widely used metric, companies will often try to strip out certain expense items, just to prop up EBITDA artificially.