EBITDA
Earnings before interest, taxes, depreciation, and amortization — the standard earnings base used to value larger, professionally managed businesses.
EBITDA starts from net income and adds back interest, taxes, depreciation, and amortization — expenses that vary by financing structure, tax jurisdiction, and accounting method rather than by how well the core business actually operates. The result approximates the cash-generating power of operations alone, independent of how the business is financed or taxed.
It's typically expressed as a valuation multiple (EV/EBITDA) and is the standard earnings base for larger, professionally managed businesses. Smaller, owner-operated businesses are usually valued on SDE instead, since EBITDA doesn't add back the owner's own salary the way SDE does — using the wrong one for a given business size systematically over- or under-values it.
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You can reach EBITDA from either end of the income statement. Both routes land on the same number if the statement is clean.
EBITDA margin is EBITDA divided by revenue. It is the number most people quote when comparing two companies in the same industry, because it strips out differences in financing (interest), tax situation and the accounting for long-lived assets.
EBITDA is a non-GAAP measure. There is no official definition, so two companies can report different EBITDA figures for the same business. When you compare, check what each side included. In the United States, public companies that report EBITDA must also reconcile it to net income.
Worked example: a regional service company
A regional HVAC service company has $2,400,000 in revenue. Cost of goods sold (technician labor and parts) is $1,320,000. Operating expenses other than depreciation are $610,000, depreciation and amortization is $150,000, interest expense is $70,000, and the tax rate is 25%.
| Line | Amount |
|---|---|
| Revenue | $2,400,000 |
| Cost of goods sold | ($1,320,000) |
| Gross profit | $1,080,000 |
| Operating expenses (excluding D&A) | ($610,000) |
| Depreciation and amortization | ($150,000) |
| Operating income (EBIT) | $320,000 |
| Interest expense | ($70,000) |
| Pre-tax income | $250,000 |
| Income tax at 25% | ($62,500) |
| Net income | $187,500 |
From the middle: $320,000 operating income + $150,000 D&A = $470,000. From the bottom: $187,500 net income + $70,000 interest + $62,500 tax + $150,000 D&A = $470,000. The EBITDA margin is $470,000 ÷ $2,400,000 = 19.6%.
Notice what moved. Net income is $187,500 and EBITDA is $470,000, a gap of $282,500 that consists entirely of interest, tax and depreciation. Whether that gap matters is the subject of the next section.
EBITDA is not cash flow
EBITDA leaves out several items that consume real cash. Follow the same company from EBITDA down to what is left. Assume it spent $210,000 on new vehicles and equipment, increased its receivables and inventory by $40,000, and repaid $60,000 of loan principal.
| Step | Amount |
|---|---|
| EBITDA | $470,000 |
| Cash taxes | ($62,500) |
| Interest paid | ($70,000) |
| Capital expenditure | ($210,000) |
| Increase in working capital | ($40,000) |
| Cash generated before debt repayment | $87,500 |
| Loan principal repaid | ($60,000) |
| Cash left for the owners | $27,500 |
A company that reports $470,000 of EBITDA has $27,500 left after servicing its business. The point is that EBITDA is the right tool for comparing operating performance and the wrong tool for judging whether a business can afford its debt, its equipment or its growth. Warren Buffett has criticized it on exactly these grounds, because a business that must keep replacing worn assets can't treat depreciation as if it were imaginary.
Two quick adjustments help. EBITDA minus capital expenditure ($470,000 − $210,000 = $260,000) is a better proxy for the cash a capital-heavy business really generates. And lenders look at DSCR rather than EBITDA alone because DSCR includes principal repayment, the cost that this bridge shows most clearly.
Adjusted EBITDA and add-backs
In a sale or a loan application, the number that gets quoted is usually adjusted EBITDA: EBITDA plus add-backs for costs that a buyer or lender agrees won't continue. Add-backs matter because the result is multiplied by a valuation multiple.
Suppose the HVAC company had a $35,000 one-time legal settlement, and the owner pays herself $190,000 for a job a replacement manager would do for $150,000, so $40,000 of her pay is above market. Adjusted EBITDA is $470,000 + $35,000 + $40,000 = $545,000. At an illustrative 5× multiple, the business is worth $2,350,000 on reported EBITDA and $2,725,000 on adjusted EBITDA. Those $75,000 of add-backs move the price by $375,000.
That sensitivity is why buyers challenge add-backs line by line, often through a quality of earnings review. An add-back tends to survive when it is genuinely non-recurring, unrelated to running the business, and supported by an invoice, contract or payroll record. It tends to fail when the same "one-time" cost shows up three years in a row, or when the business would have to pay the cost to operate under a new owner. See adjusted EBITDA for the full test.
EBITDA in valuation and lending
Buyers quote price as a multiple of EBITDA because it lets them compare businesses with different debt loads and tax positions. Enterprise value divided by EBITDA is the EV/EBITDA multiple. Multiples vary widely by industry, size and growth, so treat any quoted number as a starting point rather than a rule, and never apply a large-company multiple to a small business without adjusting.
Lenders use EBITDA in two ratios. Debt to EBITDA measures how many years of EBITDA it would take to repay the debt. With $600,000 of debt and $470,000 of EBITDA, the company is at 1.28×. Interest coverage, EBITDA divided by interest expense, is $470,000 ÷ $70,000 = 6.7×. Loan agreements often set a covenant such as a maximum debt-to-EBITDA ratio, and breaching it can allow the lender to demand changes even when payments are current.
Where EBITDA misleads
- Capital-heavy businesses. A trucking company and a consulting firm can report the same EBITDA margin while one has to keep buying equipment. Compare them on EBITDA minus capex, not EBITDA alone.
- Lease accounting. Under IFRS 16, most lease costs are moved out of operating expenses into depreciation and interest, which raises EBITDA. Under US GAAP, operating lease cost generally stays in operating expenses. Two otherwise identical companies can show different EBITDA depending on the accounting framework.
- Stock-based compensation. Some companies add it back. It is a real cost paid in shares rather than cash, so an EBITDA that excludes it flatters profitability.
- Negative EBITDA. A startup with $1,200,000 of revenue and −$300,000 of EBITDA can't be valued on an EBITDA multiple at all. Revenue multiples and runway are the usual tools there.
- Working-capital-heavy businesses. A distributor that must fund inventory and receivables can show healthy EBITDA and still run short of cash. Look at the cash conversion cycle alongside it.
Common mistakes when calculating EBITDA
- Adding back depreciation twice. If your operating income is already before depreciation, adding D&A again overstates EBITDA. Confirm which line items include it.
- Including non-operating income. A gain on selling a building or investment income raises net income but has nothing to do with running the business. Remove it before you quote EBITDA.
- Calling a recurring cost one-time. Restructuring, legal costs and marketing campaigns that repeat every year are operating costs, not add-backs.
- Comparing across different definitions. One source's EBITDA may include add-backs and another's may not. Ask for the reconciliation to net income.
- Using EBITDA as a stand-in for cash. The bridge above shows the $442,500 gap between EBITDA and what the owners actually kept. Use a cash-based measure for cash decisions.
What EBITDA can't tell you
EBITDA says nothing about whether a business can pay its debts, replace its equipment or fund growth. It is a comparison metric for operating performance before financing and accounting choices. For the cash questions, look at operating cash flow, free cash flow and DSCR. To run the calculation from your own numbers, use the EBITDA calculator.
Frequently asked questions
Earnings before interest, taxes, depreciation and amortization. It measures operating profit before financing costs, tax and the non-cash charges for using up long-lived assets.
EBITDA = net income + interest + taxes + depreciation + amortization, or equivalently operating income + depreciation + amortization. In the worked example, $320,000 of operating income plus $150,000 of D&A gives $470,000.
No. EBITDA ignores cash taxes, interest, capital expenditure, changes in working capital and loan repayments. In the example, $470,000 of EBITDA turns into $27,500 of cash left for the owners after those items.
Compare it with similar companies rather than a universal target, because margins differ by industry. Software businesses typically carry higher EBITDA margins than restaurants or distributors because their costs are structured differently. The example company's 19.6% would be strong in some sectors and ordinary in others.
Adjusted EBITDA adds back costs a buyer or lender agrees are non-recurring or unrelated to operations, such as a one-time legal settlement or above-market owner pay. Because the result is multiplied by a valuation multiple, add-backs directly change price, and buyers verify each one.
Yes. Negative EBITDA means the business loses money from operations before interest, tax and depreciation. It is common in early-stage companies, and EBITDA multiples don't apply to them. Cash burn and runway are more useful measures.