What is EBITDA?

EBITDA stands for earnings before interest, taxes, depreciation and amortization. It starts with net income and adds back interest expense, income taxes, depreciation and amortization.

Why people use it

EBITDA aims to show how much the core operations earn, independent of how the business is financed, its tax situation and past capital spending. It is widely used in business valuation, lending covenants and comparing companies of different sizes.

Example

A company reports net income of $120,000, with $20,000 interest, $30,000 income taxes and $50,000 depreciation. EBITDA is $220,000.

Adjusted EBITDA and seller's discretionary earnings

When small businesses are bought and sold, buyers often look at adjusted EBITDA or seller's discretionary earnings, which also add back owner compensation and one-time or personal expenses. These adjustments must be documented carefully, and buyers will test them against the books.

Limitations

EBITDA ignores real costs:

• Equipment eventually needs replacing, so depreciation reflects a genuine economic cost
• Interest and taxes must be paid in cash
• Working capital needs, such as growing inventory, are not reflected

It is not a measure of cash flow and is not defined by generally accepted accounting principles; see GAAP.

For small businesses

EBITDA is most useful when comparing performance over time or preparing for financing or a sale. Reliable figures depend on clean books with interest, depreciation and owner costs clearly separated. Our accounting services prepare EBITDA reconciliations from reconciled financial statements, and our guide on financial ratios covers other measures.

Related terms

• Amortization: Amortization spreads the cost of an intangible asset, or the repayment of a loan, over time.
• Net Income: Net income is what remains after all expenses are subtracted from revenue for a period.
• Working Capital: Working capital is current assets minus current liabilities, the resources available to run day-to-day operations.
• GAAP: GAAP, generally accepted accounting principles, is the standard framework for financial reporting in the United States.

Browse more definitions in the small business glossary.