Treasury Practice


Published: May 2011

EBITDA stands for Earnings Before Interest, Tax, Depreciation and Amortisation. It is a measure of a company’s profitability and shows how much money the company has made before interest, taxes, depreciation and amortisation have been deducted.

How is it calculated?

\(\mathrm{EBITDA}={\mathrm{operating\: income\:+\:depreciation\:+\:amortisation}}\)

  • Operating income (or Earnings Before Interest and Tax (EBIT)) = net income + interest + taxes.
  • Depreciation is a non-cash expense which is used to account for a tangible asset’s reduction in value over time by deducting capital expenses during the period in which the asset is used. This is sometimes described as ‘writing off’ the asset over time.
  • Amortisation is like depreciation but refers to intangible assets, such as the goodwill that may arise when a company is acquired for more than the value of its net assets.


The EBITDA measure gained popularity in the 1980s as a means of determining how profitable leveraged buyouts might be as it gives an indication of the company’s ability to service debt.

EBITDA is seen as a measure that enables comparisons between companies that have different capital structures, as it ignores interest charges. By excluding taxes, it also makes it possible to compare companies in different countries which may be subject to different tax regimes. It is often used in loan covenants.

EBITDA is also sometimes viewed as a measure of cash flow because non-cash expenses are added back. However, the key difference is that operating cash flow takes into account working capital fluctuations (ie changes in receivables, payables and inventories on the balance sheet) whereas EBITDA does not.


EBITDA is widely seen as an unreliable measurement for a number of reasons. It is not defined by GAAP and is therefore susceptible to manipulation by companies that want to make their earnings look stronger than they really are. Different companies may define amortisation and depreciation in different ways and companies can even change the way in which EBITDA is measured in different reporting periods. In 2002, it was discovered that fallen giant WorldCom had inflated its EBITDA to the tune of $3.8 billion by reclassifying certain operating costs as capital costs which could then be depreciated over time, thus delaying the recognition of these costs while still recognising the associated revenues.

Other criticisms of EBITDA include:

  • Interest and tax may be significant costs and it is misleading to exclude them from a measurement of profitability.
  • Capital expenditure required to replace short-lived assets is not taken into account. EBITDA is therefore more appropriate as a measurement of companies with long-lived assets.
  • Fluctuations in working capital are not taken into account by EBITDA.

Consequently it is advisable to use EBITDA with caution and only in conjunction with other measurements.

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