EBITDA Explained: Definition & Financial Performance

EBITDA is defined as earnings before interest, taxes, depreciation and amortization. It is used as a financial calculation to determine the financial performance of a company. The formula takes the revenue of a company, and deducts certain expenses. The expenses that are deducted are the taxes, interest, depreciation and amortization. While it is not an accurate way to chart profitability, it can provide an idea about performance.

How It Works

When determining where to invest money into a company, an investor will want to know the profitability performance. The EBITDA provides the investor an understanding of how the company has performed financially before deductions and its growth potential. It is especially important for newly established business that has not had to deal with creditors or pay out taxes. When the EBITDA figure is positive, then the investor will be more than likely to invest his or her money. In addition, the EBITDA will demonstrate to the investor the ability to have a return on investment.

Problems

There are pitfalls with an EBITDA calculation. One pitfall is that EBITDA leaves out certain expenses. Due to expenses being left out of the calculation, the company’s profitability is skewed. Another pitfall is that it does not account for the actual cash flow coming into the business.