The EBITDA definition is earnings before interest, taxes, depreciation, and amortization. It measures a company’s financial performance by computing earnings from core business operations, without including the effects of capital structure, tax rates and depreciation policies. It is used as a proxy for a company’s operating cash flow and is not defined under GAAP. EBITDA is often used to value a company, with the enterprise value of a company calculated as a multiple of its EBITDA.
EBITDA is usually expressed in industry on an annual basis, though just like any other earnings or cash flow measure it is also expressed on a quarterly or monthly basis. While last year’s EBITDA may be useful in assessing the performance of a company close to the start of the following year, it will lose its timeliness later on during that following year. To address that, you will often see a company’s EBITDA given for the last twelve months. Express it also as “LTM EBITDA.”
Factors that are ignored in EBITDA do have a material effect on a company’s cash flows. For example, the EBITDA calculation ignores changes in working capital, investing cash flows such as capital expenditures and asset sale proceeds, and financing cash flows such as proceeds from the issuance of equity, dividends and loan payments. EBITDA will also provide a misleading measure of cash flow for companies that require significant and recurring investments in fixed assets.
For companies which exhibit stable working capital requirements, EBITDA can be a useful estimate of operating cash flow. In addition, EBITDA can be a useful estimate of total cash flow if investing and financing cash activities are relatively small. EBITDA’s wide acceptance as a measure of operating performance and cash flow makes it useful. But it is important to understand its limitations. If you require an accurate measure of a company’s operating cash flow or total cash flow, then you may have to disregard its EBITDA. Instead, focus on the measures of operating cash flow and total cash flow reported in its Statement of Cash Flows. EBITDA is a great indicator of value.
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