EBITDA - Earnings Before Interest, Taxes, Depreciation & Amortization Expense

EBITDA stands for Earnings before Interest, Taxes, Depreciation & Amortization expense. EBITDA is a tool to measure the value of a firm based on its net earnings before non-cash expenses (depreciation & amortization) are recorded, as well as dilutive expenses such as interest expense & taxes. EBIDTA is used by financial valuation experts to measure the true value of a business, especially for private capital firms. Here is why private capital banks like the EBITDA formula:

i) Interest & Taxes - Replace current tax rates & Interest rates with their own tax & interest rates based on the current & new capital structure of the corporation, new debt convenants or refinancing with the banks.

ii) Amortization & Depreciation - These are excluded because they are non-cash expenses for capital or intangible assets which were acquired in prior periods, and do not represent a cash outlay of the organization.

Financial advisors recommend using EBITDA as a way to measure the cash generation activities of an organization. The formula for Earnings before Interest, Taxes, Depreciation & Amortization is:

As an example, let's calculate the EBITDA for Checkpoint Software Technology Ltd.

What is EBITDA?

Drawbacks of using EBITDA

• EBITDA excludes Interest expense & Income taxes however these are cash expenses and obviously must be paid by the company.
  
• EBITDA does not factor in changes in Working Capital which could significantly affect Cash.
  
• EBITDA does NOT exclude all non-cash items apart from amortization & interest expense. Examples of such non-cash items include stock options warranted, Inventory markdowns, allowance for doubtful accounts, etc.
  
• EBITDA could be misleading due to the fact that a company could understate its Warranty expenses, reserve for bad debt allowances, corporate restructure costs, inventory writedowns and this will lead to a higher EBITDA.