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EBITDA or “earnings before interest taxes depreciation and amortization” is a commonly used measure of cash flow. EBITDA can be calculated “top down” by adding back DDA or depreciation and amortization deducted as sales costs to operating income before interest and taxes. EBITDA can also be calculated “bottom up” by adding interest and DDA back to pretax income. For example, to find EBITDA, if the income statement shows $2 million of pretax income and DDA is $12 million and interest expense $6 million, then EBITDA is $20 million. EBDITA became a standard tool for measure cash flow leverage for LBOs in the 980s. An EBDITA/debt ratio at a 2x multiple was considered the limit of safe leverage. EBITDA is often the cash flow measure most often associated with profitability comparison between investments. For example, enterprise value/EBITDA provides a valuation multiple of all of a company’s debt and equity times its cash flows. EBITDA is not a GAAP approved accounting measure because EBITDA neutralizes the effects of a company’s financing and accounting decisions. |
