Why EBITDA?

Sure, it's important to understand how much a company earns. A company's earnings, formed by subtracting costs and expenses from from total revenue, provide a good indicator of business performance. And while shareholders and management alike care about this bottom line number, it's just as important to understand the company's EBITDA. EBITDA measures a company's earnings before interest, taxes, depreciation, and amortization. In other words, it assesses the company's operating income. This is important for a couple of reasons.

 

First, because EBITDA assesses earnings before depreciation and amortization, both non-cash expenses, EBITDA is the income statement’s answer to cash flow. While the number isn’t pure cash, it is certainly closer to cash than other numbers on the income statement. By analyzing earnings before these two numbers are subtracted, one gets a better sense of performance on cash basis.

 

EBITDA is also important because it provides a better assessment of a company's operating income. Since it excludes interest, a cost of financing, and taxes, a product of tax strategy, it looks at how much a company earns from its core operations. This is important since a business is best compared against its peers on an operational level. In other words, comparing two companies based on EBITDA allows for an apples to apples comparison based on the performance of the business.

 

While EBITDA is important, be aware that it is not a GAAP (generally accepted accounting principles) number. There can be variations in how this is calculated so always look for an explanation detailing which numbers were included and which were excluded.

 

Reuben Advani is the president of The BARBRI Financial Skills Institute and the author of two finance books. More information on this and other topics can be found at http://legalpractice.barbri.com.

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