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EBITDA is one of the most crucial measures in accounting and investment banking. It is a measure of financial performance that excludes one time and financial accounting subtleties in order to show a more accurate picture of a company’s financial state. EBITDA is calculated a revenue less expenses, excluding tax, interest, depreciation and amortization.

The purpose of EBITDA is to exclude extraneous events and charges from a company’s financial performance in an effort to get a better idea about what the company is doing.

Example #1: Say a company is getting taxed as a rate much higher than peers because of an industry penalty or higher regulations that year. This would make net income after taxes look artificially low because of the one time charges for tax. EBITDA takes care of this issue by filtering out taxes.

Example #2: A company has a ton of capital investments in machinery and tools, which are depreciating. The depreciation would make the net income of the corporation look lower than it really is from and EBITDA perspective.

By using EBITDA you can filter out artificial variation in a company’s performance and compare it much more easily to peers.

What does GAAP mean? If you’re a small business owner, you probably haven’t had time to concern yourself with some of the more arcane subjects in the world of accounting. If you’re a bookkeeper or accountant, you’ll be familiar with GAAP and know that it means Generally Accepted Accounting Principles.

Generally Accepted Accounting Principles (GAAP) is basically a common set of accounting standards that companies use to run their accounting and finances. It is a standard designed to ensure consistency and reliability of financial reporting for investment purposes. All accountants and CPAs will be very knowledgeable about GAAP but you should know a few things for yourself as well.

Key Principles of GAAP

Accounting Entity: The business, revenue, and costs are separate from the owners and operators of the business. All business finances should be kept separate from owners.

Going Concern: This assumes the business will continue into the foreseeable future, validating methods of depreciation.

Monetary Unit: Basically this just means a stable and reliable currency will be the unit of record, not an issue in the US or Euro Area.

That’s the big fuss over amortization and depreciation? Amortization and depreciation are wonky and arcane topics in the world of accounting and business finance. If you’re a small business owner or entrepreneur terms like this can be incredibly intimidating and complex.

Depreciation

Basically amortization and depreciation are ways of accounting for things declining in value naturally over time. A great example is the rusted tractor shown above. At one point in time the tractor was an asset on the farm’s balance sheet. The tractor was basically paid for with cash and a new line item on the balance sheet was created. Note that this is a capital good, so it did not affect the income statement or expenses side of the accounting equation. Over time, the tractor rusted and became useless, but it was still on the balance sheet as an asset. In order for the balance sheet to accurately reflect the assets of the farm or organization, an accountant needs to depreciate the value of the tractor over time by creating expenses that remove it gradually from the assets. This accounting method accurately.

Amortization

Amortization is the same exact thing as depreciation, except that it refers to the process in which intangible assets lose value over time. A great example is a brand name that was acquired by a company. Over time the goodwill or intangible value over book value paid for the company needs to be written off. This process of amortization is the same in every way as depreciation but goes by a different name. There you have it! Fairly simple and straightforward.