What Does
Earnings Before Interest Taxes Depreciation And Amortization Mean?
Earnings before interest, taxes, depreciation and amortization (EBITDA) is not defined by accounting standards, but is often referred to when assessing a company’s operating performance. EBITDA represents the earnings from operations before deducting interest from long-term debt, taxes and non-cash depreciation and amortization on tangible and intangible assets.
EBITDA is used often in company valuations because it is a good proxy for operating cash flow. It provides the operating cash a business could generate if net working capital is maintained from year to year. Interest, depreciation and taxes are all excluded from the calculation because interest and taxes can vary greatly by buyer, depending on their capital structures and tax rates, or because the expenses themselves are considered to be non-cash.
Divestopedia Explains Earnings Before Interest Taxes Depreciation And Amortization
EBITDA is at least one of the ways that a buyer estimates the value of a target. While the discounted cash flow method is a better tool, the multiple of EBITDA method is often used as a way to assess the reasonability of the estimated enterprise value.
When a multiple of EBITDA calculation is used, the buyer determines the enterprise value of the company and then deducts the net debt (total debt less cash on hand) to determine the equity value of the company.
Depreciation and amortization are also excluded because they are non-cash expenses of the business. This assumption works well for businesses that are not capital intensive. This is because EBITDA more closely resembles the actual operating cash before taxes that the company would realize, as there would be no significant sustaining capital spending required.
For a more capital intensive business, a buyer will usually subtract from EBITDA the estimated annual capital expenditures required to sustain the business and then apply a multiple to the net number. When sustaining capital expenditures closely resemble annual depreciation, the “DA” in EBITDA is a real cash cost and, therefore, should not be excluded. In capital intensive businesses, earnings before interest and taxes (EBIT) can be a better valuation metric.