When evaluating a company’s financial health, especially during a sale, merger, or acquisition, one term shows up again and again: EBITDA. This acronym stands for Earnings Before Interest, Taxes, Depreciation, and Amortization, and it’s commonly used as a quick way to estimate a company’s operating performance and overall value.
But what makes EBITDA so important, and why look at it instead of simply reviewing net profit? Let’s break it down.
EBITDA helps isolate the income driven by a company’s ordinary, day-to-day operations, smoothing out external factors that can distort the picture. While net profit includes all expenses, EBITDA removes several items that may not reflect the company’s true operating performance—or may not exist once ownership changes.
If a company carries significant debt, its interest expense may be high. But interest costs don’t tell you anything about whether the company’s core products or services are profitable.
Additionally, a buyer may choose to finance the acquisition differently—or not borrow at all. Because interest depends on each owner’s capital structure, it’s added back when calculating EBITDA.
Income taxes (local, state, and federal) can vary widely depending on:
Corporate structure
Location
Tax planning strategies
Credits and deductions
After an acquisition, a company’s tax situation could look completely different. EBITDA neutralizes these differences by adding taxes back to earnings, helping investors compare businesses on equal footing.
Depreciation and amortization (D&A) represent the gradual write-off of assets purchased in prior periods. The cash was spent long ago, so these expenses don’t reflect current operating performance.
Because D&A is a non-cash expense, it’s added back when calculating EBITDA.
A key tip:
Make sure you’re using the depreciation and amortization figures from the statement of cash flows. On the income statement, they may be spread across COGS or operating expenses and not clearly visible.
Critics point out that EBITDA is not a true measure of cash flow from operations. It doesn’t account for capital expenditures, changes in working capital, or financing decisions.
Still, EBITDA remains widely used because:
It’s easy to calculate
It allows quick comparison across companies and industries
Trends in EBITDA over time can signal improving or declining performance
While it shouldn’t be the only metric used, it can be a valuable starting point for assessing a company’s financial strength.
EBITDA offers a simplified, standardized way to evaluate operating performance—especially useful when comparing acquisition targets or assessing a company before a potential sale. Understanding what it includes (and doesn’t include) can help business owners, buyers, and investors make more informed decisions.
Associate Partner
Julie has over 20 years of experience in public and private accounting, representing varied clientele including the medical, legal, and real estate industries and trusts.
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