Perhaps the most central component to business is the ability, nay, the obligation, for private enterprises to seek financial profits for shareholders. However, profitability is often skewed by a number of factors including taxes, financing, and asset depreciation. That’s where EBITDA comes into play.
Starting with the abbreviation itself, EBITDA stands for Earnings Before Interest, Taxes, Depreciation, and Amortization. But to understand it’s function, it’s typically helpful to think in reverse.
Net income, or earnings, is a measure of a company’s profitability. However, it doesn’t always tell the entire story of a company.
Say taxes are high one year, but are expected to decrease. A large interest payment was due in 2018, but won’t be due in the future. An expensive asset was significantly depreciated. These would all impact net income, but aren’t entirely reflective of the core operation.
EBITDA takes just the earnings before considering interest, taxes, depreciation (the loss in value of an asset over time), and amortization (allocating costs over time). So, it can often be a good measure of a company’s core operation.
This is not to say EBITDA as a measure will or should supplant Net Income anytime soon. However, being familiar with the term and its role makes understanding financial statements — despite not itself being a standard measure — easier.
Also, shout-out to the man who drives around Boston’s financial district with his “EBITDA” license plate.
(Pop quiz! Is EBITDA an acronym? Find out in tomorrow’s post!)