EBITDA, explained simply
Because EBITDA removes the effect of capital structure, tax position and asset age, it allows businesses to be compared and is the measure on which most private company transactions are priced and financed.
It is not a GAAP measure, so definitions vary, and it is not cash: it excludes capital expenditure, working capital movements and cash taxes.
Building EBITDA from revenue
IllustrativeAlder Creek Manufacturing, $ millions
EBITDA of $5.0 million is 11.9% of revenue.
Calculation
Equivalently: revenue − cost of goods sold − operating expenses, excluding depreciation and amortization.
Worked example
| Alder Creek, $ millions | Amount |
|---|---|
| Revenue | 42.0 |
| Cost of goods sold | (28.0) |
| Gross profit | 14.0 |
| Operating expenses (excluding D&A) | (9.0) |
| EBITDA | 5.0 |
| Depreciation and amortization | (0.8) |
| Operating profit (EBIT) | 4.2 |
| Interest | (0.5) |
| Income taxes | (0.8) |
| Net income | 2.9 |
Alder Creek Manufacturing, Inc. is a fictional company. All figures are illustrative.
Limitations
- Excludes capital expenditure, so asset-heavy businesses can show high EBITDA and low free cash flow.
- Excludes working capital movements and cash taxes.
- Is a non-GAAP measure, so definitions differ and must be reconciled in diligence.
Why it matters in a deal
Buyers typically price private companies as a multiple of EBITDA and lenders size debt on it. It is the single most important figure in most middle market transactions.
Red flags
- EBITDA rising while operating cash flow falls
- Heavy capital expenditure requirements masked by EBITDA
- Inconsistent definition of EBITDA between documents