What is EBITDA, and why do bankers use it?

EBITDA is earnings before interest, taxes, depreciation and amortization. You can get to it by taking operating income, or EBIT, and adding back depreciation and amortization. Bankers use it as a rough proxy for the cash flow a company's operations generate. Depreciation and amortization are non-cash charges, so adding them back gets closer to cash. It also makes companies easier to compare. Because it's before interest, it doesn't depend on how much debt a company has, and because it's before taxes and depreciation, it isn't affected by different tax situations or depreciation policies. It does have limits. It ignores capital expenditures and changes in working capital, so it can overstate cash flow. It's also not a GAAP measure, so companies define adjusted EBITDA in their own way, and I'd check what's been added back.

EBITDA is earnings before interest, taxes, depreciation and amortization. You can get to it by taking operating income, or EBIT, and adding back depreciation and amortization. Bankers use it as a rough proxy for the cash flow a company's operations generate. Depreciation and amortization are non-cash charges, so adding them back gets closer to cash. It also makes companies easier to compare. Because it's before interest, it doesn't depend on how much debt a company has, and because it's before taxes and depreciation, it isn't affected by different tax situations or depreciation policies. That's why EV to EBITDA is one of the most common valuation multiples, and why lenders measure debt as a multiple of EBITDA. It does have limits. It ignores capital expenditures and changes in working capital, so it can overstate cash flow. For a capital-intensive business, like a manufacturer or an airline, the gap can be large, so I'd also look at EBITDA minus capex. It's also not a GAAP measure, so companies define adjusted EBITDA in their own way, and I'd check what's been added back. So I'd treat EBITDA as a starting point for comparing companies, and go to free cash flow when I need to know what's really left for investors.