01What EBITDA removes, and why it matters
The acronym says what is excluded: interest, taxes, depreciation and amortisation. The first two exclusions have a clear logic (they strip out how the company is financed and where it pays tax, so that businesses can be compared) and almost nobody argues with that part.
The arguable ones are the other two. Depreciation is not an arbitrary accounting entry: it is the annual acknowledgement that machines, trucks, stores and servers wear out and have to be replaced. Taking it out of the calculation is equivalent to assuming the asset lasts forever.
That is what sat behind the most quoted objection in the trade, and it remains the best formulation of the problem: does management really think the tooth fairy pays for capital expenditure?
02Two companies, identical EBITDA, four times the cash
Two companies turn over $500M and both report EBITDA of $200M. In a headline they are identical. Underneath:
- Company A, software. Capex $20M, interest $0, tax $40M. Free cash flow: $140M.
- Company B, capital-intensive industry. Capex $120M, interest $35M, tax $10M. Free cash flow: $35M.
The same $200M of EBITDA produces four times more free cash in one than in the other. And if the multiple they trade on is computed over EBITDA (EV/EBITDA, which is the standard), both look equally priced per unit of «operating profit» when one hands over four times the spendable money.
The figures in the example are invented and rounded so the arithmetic can be redone by hand. They belong to no real company. The shape, however, is real: it is exactly what separates a software business from a utility, a shipping line or a telco.
03When EBITDA is the right figure
Criticising it does not make it useless, and misusing it is not the metric's fault. There are three situations where it is precisely what to look at:
- Comparing the operating business of two companies with different debt loads or tax regimes. It is what it was invented for.
- Measuring leverage. Net debt to EBITDA is the language of banks and loan agreements, and the thresholds that trigger a covenant are usually written in it.
- Asset-light businesses, where depreciation is small and EBITDA is a reasonable proxy for cash.
What does not work is the opposite: using it on a capital-intensive business and presenting it as though it were spendable money.
04The «adjusted EBITDA» trap
EBITDA is already an unregulated figure: it does not appear as such in the audited accounts, it is constructed from them. Adjusted EBITDA adds a second layer of the company's own judgement, adding back whatever it deems extraordinary: restructuring, integration costs, share-based compensation.
The useful question is not whether the adjustments are legitimate, but how often they repeat. An exceptional restructuring is exceptional once; when it shows up in the adjustment five years running, it is an ordinary cost under another name.
And the adjustment most worth watching is share-based pay. It is a real cost (it dilutes existing shareholders) and it is among the most frequently excluded.
05Three one-minute checks
- Divide capex by EBITDA. If it takes more than half, EBITDA is not telling you much about cash.
- Compare it against free cash flow for the same year. A stable gap is the nature of the business; a gap that widens every year deserves an explanation.
- Find the bridge from adjusted to reported EBITDA and check whether the same items appear every year. If they do, they were not extraordinary.
Frequently asked questions
Is EBITDA the same as profit?
No. EBITDA is earnings before interest, taxes, depreciation and amortisation, so it excludes four real costs. The first two are removed deliberately, to compare businesses with different financing or tax positions; the other two represent the wearing out of assets that have to be replaced. That is why EBITDA is not cash: two companies with the same EBITDA can generate four times more free cash flow than each other depending on how much capex they need.
What is the difference between EBITDA and free cash flow?
Free cash flow is the money genuinely left over after paying what is needed to keep operating: it starts from operating cash flow and subtracts capital expenditure. EBITDA subtracts neither that investment nor interest nor tax. In an asset-light business the two are close; in a utility, a shipping line or a telco the difference can be several times over.
Why do companies use EBITDA so much?
Because it presents them at their best and because it is unregulated: it does not appear as such in the audited accounts, it is constructed from them, and each company can define its own adjusted version. It also has legitimate uses: comparing the operating business independently of debt, and measuring leverage through net debt to EBITDA, which is the language of loan agreements.
What is adjusted EBITDA and when should you distrust it?
It is EBITDA with items the company considers extraordinary added back: restructuring, integration costs, share-based pay. The useful test is not whether each adjustment is legitimate in isolation, but how often it repeats: an item appearing in the adjustment five years running is an ordinary cost under another name. Share-based compensation deserves particular attention, because it is a real cost that dilutes shareholders.
The figures in the two-company example are invented and rounded so the arithmetic can be redone by hand. They correspond to no real company.
This is information and analysis, not financial advice, and it contains no recommendation to buy or sell. See the disclaimer.
