What is EBITDA?

Earnings before interest, taxes, depreciation and amortization or, to give it its acronym, EBITDA, is a measure of a company's cash flow before certain deductions. It allows investors to see how much money a company is making before taxes, depreciation and amortization have been deducted. Basically, when investors place money in a company, they will want to know how much money the company has been making since their money was invested. EBITDA gives the investor an idea of how much money the company has made before its deductions. It is especially useful for a new company who has just started business and has not yet been hit with taxes, payments to creditors, and so on.

If the EBITDA figure seems to have a good growth rate, then some investors may use this figure instead of the overall net figure. It can show them that the company has a future for potential growth and that they will get a return on their investment. Investors call this looking at the EBITDA margin rather than the net margin.

There are potential problems in using the EDITDA figure. The EBITDA leaves out of lot of expenses in the final figure, so it may not be a realistic view of a company’s profitability. It also does not measure the actual cash that is flowing into the company because of the figures that it leaves out.

There are a few factors that the EBITDA neglects. These include the money required for working capital, fixed expenses and other debt payments and capital expenditures. In every business, capital expenditures are a crucial, ongoing expense. However, this is not factored into the EBITDA figure, so investors need to be wary when using the EBITDA figure as a basis for a profit margin.

There are more reliable ways for investors to calculate a company's cash income. They can use the Free Cash Flow (FCF) system. The FCF is calculated by simply deducting capital expenditures from the business cash flow figure. This takes into account at least three of the factors that the EBITDA leaves out: inventory, receivables and capital expenditures such as property and equipment.

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