What is EBITDA?

Q: Is EBITDA the same as cash flow?

No. EBITDA approximates operating cash generation but ignores changes in working capital (inventory, receivables, payables), capital expenditures, and other cash items. A company can have strong EBITDA but negative cash flow if it's growing rapidly and investing heavily in inventory or equipment.

Q: Why do investors use EBITDA multiples?

EBITDA multiples allow comparison across companies regardless of their capital structure (debt levels), tax situations, or depreciation policies. A company valued at 5x EBITDA of $2M is worth $10M enterprise value. Multiples vary by industry, growth rate, and risk profile—typically 3-6x for small businesses, higher for growth companies.

Q: What's the difference between EBITDA and Adjusted EBITDA?

Adjusted EBITDA starts with EBITDA and adds back non-recurring or non-operating expenses: owner perks, one-time legal fees, non-cash stock compensation, above-market rent to related parties, etc. Adjusted EBITDA attempts to show normalized, sustainable earnings. Buyers scrutinize these adjustments carefully.

Q: Is EBITDA a GAAP metric?

No. EBITDA is not defined under Generally Accepted Accounting Principles (GAAP). Companies can calculate it differently, which is why the SEC requires reconciliation to GAAP measures in public filings. When comparing EBITDA across companies, verify the calculation methodology.

Earnings Before Interest, Taxes, Depreciation, and Amortization—the most common measure of operating profitability for business valuation.

Key Takeaways

•EBITDA measures operating profitability before financing and accounting decisions
•Used for business valuation, comparing companies, and assessing debt capacity
•Calculated by adding back non-cash expenses to operating income
•Adjusted EBITDA normalizes for owner benefits and one-time items

EBITDA Definition

EBITDA (pronounced ee-bit-dah) stands for Earnings Before Interest, Taxes, Depreciation, and Amortization. It measures a company's operating performance by showing profit from core business operations, before:

Interest: The cost of borrowed money (financing decision)
Taxes: Income taxes, which vary by structure and jurisdiction
Depreciation: Non-cash expense spreading the cost of tangible assets
Amortization: Non-cash expense spreading the cost of intangible assets

By stripping out these items, EBITDA provides a cleaner view of operational performance that can be compared across companies with different capital structures, tax situations, and asset bases.

How to Calculate EBITDA

There are two common formulas, both yielding the same result:

Method 1: Start from Net Income

EBITDA = Net Income + Interest + Taxes + Depreciation + Amortization

Method 2: Start from Operating Income

EBITDA = Operating Income + Depreciation + Amortization

Example Calculation

Revenue	$5,000,000
Cost of Goods Sold	($3,000,000)
Gross Profit	$2,000,000
Operating Expenses (incl. D&A of $200K)	($1,200,000)
Operating Income	$800,000
Add: Depreciation & Amortization	$200,000
EBITDA	$1,000,000

Why EBITDA Matters

Business Valuation

EBITDA multiples are the most common way to value private companies. A 5x multiple on $1M EBITDA = $5M enterprise value.

Comparing Companies

EBITDA allows apples-to-apples comparison across companies with different debt levels and accounting policies.

Debt Capacity

Lenders use EBITDA to assess debt capacity. A typical loan covenant might be Debt/EBITDA < 3.0x.

Performance Tracking

Track EBITDA over time to see if operational performance is improving independent of financing decisions.

Adjusted EBITDA

When selling a business or seeking investment, owners typically present Adjusted EBITDA (also called "Normalized EBITDA"), which adds back expenses that won't continue under new ownership or that are above market rate.

Common EBITDA Adjustments

Owner compensation above market: If owner takes $300K but market salary is $150K, add back $150K
Owner perks: Personal vehicles, club memberships, family members on payroll
One-time expenses: Legal settlement, COVID impact, relocation costs
Related party rent: If paying above-market rent to yourself
Non-recurring revenue: May need to subtract one-time revenue

Buyer Scrutiny

Buyers will challenge aggressive adjustments. Every add-back should be documented with supporting evidence. A Quality of Earnings report will validate (or invalidate) your adjustments. See our guides on gross margin benchmarks, customer concentration, and valuation methods.

EBITDA Margin

EBITDA Margin expresses EBITDA as a percentage of revenue, allowing comparison across companies of different sizes.

EBITDA Margin = EBITDA / Revenue × 100

Typical EBITDA Margins by Industry

Industry	Typical Margin
SaaS / Software	15-25%
Professional Services	15-20%
Manufacturing	10-15%
Distribution / Wholesale	5-10%
Retail	5-8%
Construction	8-12%

Limitations of EBITDA

While useful, EBITDA has significant limitations:

Ignores capital expenditures: A capital-intensive business needs equipment investment that EBITDA doesn't capture
Not cash flow: Working capital changes (inventory, receivables) affect cash but not EBITDA
Can be manipulated: What's included in operating expenses vs. add-backs affects the number
Ignores debt service: A highly leveraged company may have strong EBITDA but insufficient cash after debt payments
Hides capital structure risk: Two companies with identical EBITDA can have very different risk profiles based on debt

Consider Multiple Metrics

EBITDA should be one of several metrics you track. Also monitor free cash flow, working capital, debt levels, and capital expenditure requirements. Understanding pricing strategy, profit levers, and unit economics helps you improve EBITDA systematically.

Frequently Asked Questions

Is EBITDA the same as cash flow?