Let's start by breaking down the acronym.
EBITDA: earnings before interest, tax, depreciation and amortization.
It’s a company’s profit before those expenses.
Of course, equity investors ultimately care about the very bottom lines, which are net income (profit after those expense items) and free cash flow, which is just the amount of cash the company netted for a given time period. See our explainer on free cash flow.
So why do we care about EBITDA if it’s not the final line of profit?
There are several reasons, but the all encompassing reason is that this measure of profitability gives us an idea of how much profit a company is generating before non-cash expenses and before expenses that usually don’t vary very much — interest and tax.
First off, EBITDA allows us to compare two companies in the same industry with a clearer picture because we’re stripping out those expense items below this line of profit.
We look at the two companies’ enterprise value (or market cap plus net debt) as a multiple of EBITDA. We include debt in the total valuation because EBITDA is profit before interest expense, so before debt holders are paid.
Secondly, EBITDA is useful for assessing early stage growth companies like Uber and Lyft or Snap. We know we’re looking for those companies to turn net income positive, but it’s likely that they’ll do so if they’re EBITDA positive.
To see why this all matters, watch the quick video above.
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