EBITDA has become a widely used metric in business and investing circles, yet it’s often misunderstood or misused. Short for earnings before interest, taxes, depreciation, and amortization, EBITDA aims to reflect a company’s core operating performance. It’s frequently cited in dealmaking, private equity, and financial reporting, but its popularity can mask some real limitations.
In this article, we break down what EBITDA really means, how it differs from similar metrics, why investors rely on it, and where caution is warranted.
What EBITDA Really Means
EBITDA stands for earnings before interest, taxes, depreciation, and amortization. It offers a snapshot of a company’s operational performance, stripped of financial structure and accounting choices. The idea is to isolate profit generated through normal business activity, without the noise of financing decisions, local tax rules, or large non-cash charges.
To calculate EBITDA, analysts usually start with net income and add back interest expense, tax expense, depreciation, and amortization. Some prefer starting with EBIT (earnings before interest and taxes) and then adding depreciation and amortization from there.
Either method leads to the same place: a figure that gives an idea of recurring operational earnings before non-operating or accounting-driven items come into play.
How EBITDA Differs From EBIT & Operating Income
While EBITDA and EBIT are often mentioned together, they are not interchangeable. EBIT stops after removing interest and taxes from net income, leaving depreciation and amortization untouched. EBITDA goes further by removing those as well, which often leads to a larger number, especially for companies with significant fixed assets.
For companies with heavy capital investment, such as telecom providers or energy infrastructure firms, EBITDA can look much stronger than EBIT. It can create a more favorable image of profitability, even though those non-cash expenses represent real long-term costs tied to equipment and assets.
Why Investors Focus On EBITDA
EBITDA remains popular because it smooths out differences that can make comparing businesses difficult. Interest expense depends on a company’s financing choices, which vary widely. Some companies carry significant debt; others stay nearly debt-free. EBITDA removes this variable, which can help investors compare operational efficiency across different capital structures.
Tax expense is another factor that varies by location, regulation, and specific tax credits or deductions. Stripping out taxes offers a clearer view of how a business performs before jurisdictional differences come into play. Depreciation and amortization are non-cash expenses, often tied to past investment decisions or intangible assets. While EBITDA excludes non-cash charges, it does not account for working capital changes or capital expenditures, making it a rough estimate of operational performance, not actual cash flow. Because of these qualities, EBITDA often plays a role in debt agreements, especially when setting performance covenants.
It also serves as the denominator in common valuation multiples like EV/EBITDA, which compares enterprise value to operational performance. In stable industries, 8 to 10 times EBITDA is often cited as a fair range. Growth sectors like SaaS can see multiples as high as 14 to 18 times, depending on market conditions and expectations.
Where EBITDA Can Mislead
Despite its usefulness, EBITDA has received its share of criticism. Some have criticized that removing depreciation and amortization ignores the real cash costs of maintaining and replacing business assets.
Asset-heavy businesses often show strong EBITDA while still bleeding cash. Airlines, for instance, may report a positive EBITDA figure even during years when their capital expenditures far exceed their cash from operations.
Adjusted EBITDA is another metric that often raises questions; companies often modify the standard EBITDA calculation by adding back items they label as non-recurring. Some of these adjustments are reasonable. One-time restructuring costs, disaster-related losses, or asset impairments can distort a company’s normal earnings, so excluding them helps clarify the core picture.
Others, though, are more questionable. Various factors such as ongoing legal fees, stock-based compensation, and regular rent adjustments appear frequently in SEC comment letters, flagged as inappropriate if presented as “non-recurring.”
In M&A, adjusted EBITDA plays a key role in purchase price negotiations and is often the basis for valuation, earn-outs, or debt covenant compliance. Because of this, both buyers and sellers must carefully vet what counts as an “adjustment.”
The SEC has increased its scrutiny of these adjustments, noting in a 2024 review that nearly 30% of comment letters involved concerns with non-GAAP metrics like adjusted EBITDA. While SEC scrutiny primarily affects public companies, private company sellers preparing for a sale should still follow best practices in labeling and justifying adjustments to avoid valuation disputes.
EBITDA Margin Shows Efficiency
EBITDA margin is calculated by dividing EBITDA by total revenue, revealing how much profit is produced per dollar of revenue, before factoring in interest, taxes, or depreciation.
Margins can vary widely between sectors. Industrial REITs often report margins north of 70% due to steady rental income and low overhead. At the other extreme, early-stage biotech firms can post negative margins, sometimes reaching negative 100% or more, as they spend heavily on R&D without matching revenue.
Charts or heat maps that show average EBITDA margins by sector can help readers benchmark their own company’s performance or assess how an acquisition target stacks up.
What To Take Away From EBITDA
EBITDA is a widely used tool in financial analysis, offering a clearer look at operational earnings across industries and business models. It strips away many of the variables that complicate comparison, which makes it appealing to investors, lenders, and business owners alike.
Still, its usefulness depends on how well it’s applied. To truly understand these metrics, you need to consider the bigger picture. If you’re considering a business sale, planning an acquisition, or evaluating investment opportunities, a strong grasp of EBITDA is just the starting point. Roadmap Advisors works with business owners, investors, and family offices to provide transaction insight backed by real-world experience.
To learn more, connect with our experienced M&A Advisors by scheduling a consultation online today.