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.
