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EBITDA ee-bit-dah is the acronym for Earnings
before Interest, Taxes, Depreciation, and
Amortization. It is a non-GAAP metric that is measured
exactly as stated. All interest, tax, depreciation and
amortization entries in the Income Statement are reversed
out from the bottom line Net Income. It purports to
measure cash earnings without accrual accounting,
canceling tax-jurisdiction effects, and canceling the
effects of different capital structures.
EBITDA differs from the operating cash flow in a cash
flow statement primarily by excluding payments for taxes
or interest as well as changes in working capital. EBITDA
also differs from free cash flow because it excludes cash
requirements for replacing capital assets (capex).

Accountancy

Key concepts
Accountant Bookkeeping Trial balance General
ledger Debits and credits Cost of goods sold
Double-entry system Standard practices Cash and
accrual basis GAAP / IFRS
Financial statements
Balance sheet Income statement Cash flow
statement Equity Retained earnings

EBITDA Margin refers to EBITDA divided by total


revenue. EBITDA margin measures the extent to which
cash operating expenses use up revenue.

Auditing
Financial audit GAAS Internal audit
Sarbanes-Oxley Act Big Four auditors
Fields of accounting
Cost Financial Forensic Fund Management
Tax

1 Use by private equity investors


2 Use by debtholders
3 Use by shareholders
4 Unprofitable businesses
5 See also
6 References

In the process of purchase, long-life assets will be revalued to market values. Their depreciation and
amortization will necessarily be changed. Control of the business allows the purchaser to move it to a new
tax jurisdiction and to refinance its debt.

EBITDA is widely used in loan covenants. The theory is that it measures the cash earnings that can be used
to pay interest and repay the principal. Since interest is paid before income tax is calculated, the debtholder
can ignore taxes. They are not interested in whether the business can replace its assets when they wear

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Earnings before interest, taxes, depreciation and amortization - Wikipedi...

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http://en.wikipedia.org/wiki/EBITDA

out,therefore can ignore capital amortization and depreciation.


There are two EBITDA metrics used.
1. The measure of a debt's pay-back period is Debt/EBITDA. The longer the payback period, the greater
the risk. The metric presumes that the business has stopped making interest payments (because interest
is added back). But it is argued that once that happens the debtholder is unlikely to wait around (say)
three years to recover their principal while the business continues to operate in default. So does the
metric measure anything? There is also the problem of adding back taxes. This metric ignores all tax
expenses even though a good portion are cash payments, and the government gets paid first. Principal
repayments are not tax-deductible.
2. One interest coverage ratio (EBITDA /Interest Expense) is used to determine a firm's ability to pay
interest on outstanding debt. The greater the multiple of cash available for interest payments, the less
risk to the lender. The greater the year-to-year variance in EBITDA, the greater the risk. Because
interest is tax-deductible it is appropriate to back out the tax effects of the interest, but this metric
ignores all taxes.
The ratios can be customized by reducing Debt by any cash on the balance sheet or by deducting
maintenance CapEx from EBITDA to form a measure closer to free cash flow.

Public investors' use of EBITDA arose from their perception that accountants' measure of profits, using
accrual accounting was manipulated, that a measure of cash earnings would be more reliable.
It is true that PE can use this metric. And it is true the professional analysts using detailed discounted cash
flow models should replace non-cash expenses with projected time-weighted payments. But none of that
applies to retail investors' reality.
EBITDA does NOT measure cash earnings because it omits all the tax expenses even though a good portion
are cash payments. It also fails to correct for other non-cash expenses, e.g. warranty expense, bad debt
allowance, inventory write-down, stock options granted.
It does not include the cash flows from changes in working capital. Suppose a business sells all its opening
inventory in a year and replaces the same number of units but at a higher price because of inflation. The
profits of a company using FIFO inventory valuation will not include that extra cash cost. Suppose the
business is expanding and need to stock a larger number of units. That additional cash cost is not in anyone's
EBITDA measure.
When using this metric to replace accountant's earnings it presumes to measure an economic profit. But any
economic profit must include the cost of capital and the degradation of long-life assets. This metric simply
ignores both. Warren Buffett famously asked, "Does management think the tooth fairy pays for capital
expenditures?" Depreciation may not be exact but it is the most practical method available. It succeeds in
equating the positions of companies using three different ways to finance long-life assets. It can be
interpreted as:
1. the allocation of the original cost, at a later date, when the asset was used to generate revenue. The
time-value-of-money (same argument used above) means that depreciation may understate the cost.
2. the amount of cash required to be retained in order to finance the eventual replacement asset. Since
inflation is the basis for time-value-of-money, the amounts set aside today must be invested and grow
in value in order to pay the inflated price in the future.
3. the decrease in value of the balance sheet asset since the last reporting period. Assets wear out with
use, and will eventually have to be replaced.

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When comparing businesses with no profits, their potential to make profit is more important than their Net
Loss. Since taxes on losses will be misleading in this context, taxes can be ignored. Capital expenditures and
their related debt result in fixed costs. These are of less importance than the variable costs that can be
expected to grow with increasing sales volume, in order to cover the fixed costs. So depreciation and interest
costs are of less importance. It is likely that an unprofitable business is burning cash (has a negative cash
flow), so investors are most concerned with "how long the cash will last before the business must get more
financing" (resulting in debt or equity dilution).
EBITDA is not used as a valuation metric in these circumstances. It is a starting point on which future
growth is applied and future profitability discounted back to the present. Equity owners only benefit from
net profits, after all the expenses are paid.
During the dot com bubble companies promoted their stock by emphasising either EBITDA or pro forma
earnings in their financial reports, and explaining away the (often poor) "income" number. This would
involve ignoring one-time write-offs, asset impairments and other costs deemed to be non-recurring. Because
EBITDA (and its variations) are not measures generally accepted under U.S. GAAP, the U.S. Securities and
Exchange Commission requires that companies registering securities with it (and when filing its periodic
reports) reconcile EBITDA to net income in order to avoid misleading investors.

Earnings Before Interest, Taxes, Depreciation, Amortization, and Restructuring or Rent Costs
(EBITDAR)
Revenue
Gross profit
Earnings before interest and taxes (EBIT), or operating profit
Net profit or Net income
EV/EBITDA
P/E ratio

Investopedia definition of EBITDA (http://www.investopedia.com/terms/e/ebitda.asp)


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/wiki/Earnings_before_interest,_taxes,_depreciation_and_amortization"
Categories: Generally Accepted Accounting Principles | Fundamental analysis | Private equity
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