what does ebitda actually tell you 
by adding interest taxes depreciation and amortization back to net income ebitda can be used to track and compare the underlying profitability of companies regardless of their depreciation assumptions or financing choices like earnings ebitda is often used in valuation ratios notably in combination with enterprise value as ev ebitda also known as the enterprise multiple ebitda is widely used in the analysis of asset intensive industries with a lot of property plant and equipment and correspondingly high non cash depreciation costs in those sectors the costs that ebitda excludes may obscure changes in the underlying profitability for example as with energy pipelines meanwhile amortization is often used to expense the cost of software development or other intellectual property that s one reason early stage technology and research companies may use ebitda when discussing their performance annual changes in tax liabilities and assets that must be reflected on the income statement may not relate to operational performance interest costs depend on debt levels interest rates and management preferences regarding debt vs equity financing excluding all of these items keeps the focus on the cash profits generated by the company s business of course not everyone agrees references to ebitda make us shudder berkshire hathaway inc brk a ceo warren buffett has written according to buffett depreciation is a real cost that can t be ignored and ebitda is not a meaningful measure of performance 2example of ebitdasuppose a company generates 100 million in revenue and incurs 40 million in cost of goods sold cogs and another 20 million in overhead depreciation and amortization expenses total 10 million yielding an operating profit of 30 million interest expense is 5 million leaving earnings before taxes of 25 million with a 20 tax rate net income equals 20 million after 5 million in taxes is subtracted from pretax income if depreciation amortization interest and taxes are added back to net income ebitda equals 40 million history of ebitdaebitda is the invention of one of the very few investors with a record rivaling buffett s liberty media chairman john malone the cable industry pioneer came up with the metric in the 1970s to help sell lenders and investors on his leveraged growth strategy which deployed debt and reinvested profits to minimize taxes during the 1980s the investors and lenders involved in leveraged buyouts lbos found ebitda useful in estimating whether the targeted companies had the profitability to service the debt that was expected to be incurred in the acquisition since a buyout would likely entail a change in the capital structure and tax liabilities it made sense to exclude the interest and tax expense from earnings as non cash costs depreciation and amortization expense would not affect the company s ability to service that debt at least in the near term 3the lbo buyers tended to target companies with minimal or modest near term capital spending plans while their own need to secure financing for the acquisitions led them to focus on the ebitda to interest coverage ratio which weighs core operating profitability as represented by ebitda against debt service costs 3ebitda gained notoriety during the dotcom bubble when some companies used it to exaggerate their financial performance 4the metric received more bad publicity in 2018 after wework companies inc a provider of shared office space filed a prospectus for its initial public offering ipo defining its community adjusted ebitda as excluding general and administrative as well as sales and marketing expenses 5criticisms of ebitdabecause ebitda is a non gaap measure the way it is calculated can vary from one company to the next it is not uncommon for companies to emphasize ebitda over net income because the former makes them look better an important red flag for investors is when a company that hasn t reported ebitda in the past starts to feature it prominently in results this can happen when companies have borrowed heavily or are experiencing rising capital and development costs in those cases ebitda may serve to distract investors from the company s challenges these are among the other criticisms of ebitda a common misconception is that ebitda represents cash earnings however unlike free cash flow ebitda ignores the cost of assets one of the most common criticisms of ebitda is that it assumes profitability is a function of sales and operations alone almost as if the company s assets and debt financing were a gift to quote buffett again does management think the tooth fairy pays for capital expenditures 6while the formulas for calculating ebitda may seem simple enough different companies use different earnings figures as the starting point in other words ebitda is susceptible to the earnings accounting games found on the income statement all the cost exclusions in ebitda can make a company appear much less expensive than it really is when analysts look at stock price multiples of ebitda rather than at bottom line earnings they produce lower multiples consider the historical example of wireless telecom operator sprint nextel on april 1 2006 the stock was trading at 7 3 times its forecast ebitda that might sound like a low multiple but it didn t mean that the company was a bargain as a multiple of forecast operating profits sprint nextel traded at a much higher 20 times and the company traded at 48 times its estimated net income there s been some real sloppiness in accounting and this move toward using adjusted ebitda and adjusted earnings has produced some companies that i think are trading on valuations that are not supported by the real numbers hedge fund manager daniel loeb said in 2015 not much has changed on that front since then investors using solely ebitda to assess a company s value or results risk getting the wrong answer ebitda vs ebit vs ebtearnings before interest and taxes ebit is a company s net income plus income tax and interest expenses ebit is used to analyze the profitability of a company s core operations the following formula is used to calculate ebit since net income includes interest and tax expenses to calculate ebit these deductions from net income must be reversed earnings before tax ebt reflects how much of an operating profit has been realized before accounting for taxes while ebit excludes both taxes and interest payments ebt is calculated by adding just tax expense to the company s net income by excluding tax liabilities investors can use ebt to evaluate performance after eliminating a variable typically not within the company s control in the united states this is most useful for comparing companies that might be subject to different state tax rates or federal tax rules unlike ebitda ebt and ebit do include the non cash expenses of depreciation and amortization ebitda vs operating cash flowoperating cash flow is a better measure of how much cash a company is generating because it adds non cash charges depreciation and amortization back to net income while also including changes in working capital including receivables payables and inventory that use or provide cash working capital trends are an important consideration in determining how much cash a company is generating if investors don t include working capital changes in their analysis and rely solely on ebitda they can miss clues for example difficulties with receivables collection that may impair cash flow 