What Is EBITDA? | The Motley Fool

The acronym EBITDA stands for earnings before interest, taxes, depreciation, and amortization. EBITDA is a useful metric for understanding a business's ability to generate cash flow for its owners and for judging a company's operating performance.

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An infographic defining and explaining EBITDA: earnings before interest, taxes, depreciation, and amortization. — Image source: The Motley Fool

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Amortization

Amortization means different things in financial accounting and lending. Learn more about both kinds of amortization here.

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Overall, EBITDA is a handy tool for normalizing a company's results so you can more easily evaluate the business. To be clear, EBITDA is not a substitute for other metrics such as net income. After all, the items excluded from EBITDA -- interest, taxes, and non-cash expenses -- are still real items with financial implications that should not be dismissed or ignored.

EBITDA is often most useful for comparing two similar businesses or trying to determine a company's cash flow potential.

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Lemonade Stand A
Revenue	$1,000
Cost of Goods Sold	$200
Interest Expense	$0
Depreciation of Lemonade Stand	$50
Income Before Taxes	$750
Net Income (35% tax rate)	$487.50
EBITDA	$800

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Note that Lemonade Stand A earned $487.50 in net income, while EBITDA was $800 in the example year.

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Lemonade Stand B
Revenue	$1,000
Cost of Goods Sold	$200
Interest Expense ($1,500 at 10% interest)	$150
Depreciation of Lemonade Stand	$50
Income Before Taxes	$600
Net Income (35% tax rate)	$390
EBITDA	$800

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Because Lemonade Stand B uses substantially more debt ($1,500 at 10% interest) to finance its operations, it is less profitable in terms of net income ($390 in profits versus $487.50). However, when compared on the basis of EBITDA, the lemonade stands are equal, each producing $800 in EBITDA from $1,000 in sales last year.

What's the lesson here? By looking at EBITDA, we can determine the underlying profitability of a company's operations, allowing for easier comparison to another business. Then we can take those results and gain a deeper understanding of the impact of a company's capital structure, e.g., debt and capital expenditures, as well as differences in taxes (particularly if the companies operate in different places) on the company's actual profits and cash flows.

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Doing all that can go a long way toward helping you decide if a company is worth investing in and what price it's worth. In the example above, Lemonade Stand A would be worth more to investors since it is able to turn more of its EBITDA into net income. Lemonade Stand B isn't as profitable because of its debt expense, so investors should be compensated by paying a lower stock price.

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About the Author

Jason Hall is a contributing Motley Fool stock market analyst with more than a decade of experience writing about dividend stocks and long-term investing. He has been with the company since 2012 and previously spent over 10 years in technical sales in the printing and information services industry. Jason also founded and operated a small food manufacturing business.

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