EBITDA

Definition

EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization) is a financial metric that measures a company’s operating profitability before considering financial costs (interest), tax expenses (taxes), and non-cash accounting items (depreciation and amortization). EBITDA provides a view of core operating performance, isolating the business’s ability to generate profit from its main activities, independent of capital structure, tax regime, and accounting choices.

The basic EBITDA formula is:

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

Alternatively, starting from the top of the income statement:

EBITDA = Revenue - COGS (Cost of Goods Sold) - Operating Expenses (excluding D&A)

Where:

Revenue: total sales
COGS: direct production costs (materials, direct labor)
Operating Expenses: operational costs (R&D, sales, marketing, G&A), excluding depreciation and amortization

EBITDA is often expressed as a percentage of revenue (EBITDA Margin), indicating how many cents of each euro/dollar of revenue become EBITDA:

EBITDA Margin = (EBITDA / Revenue) × 100

A company with $10 million in revenue and $3 million in EBITDA has an EBITDA Margin of 30%. Benchmarks vary by industry: mature SaaS targets 20-40%, e-commerce 5-15%, enterprise software above 30%.

EBITDA is widely used in M&A, valuations, benchmarking, and performance analysis because it enables “apples-to-apples” comparisons between companies with different financial structures. However, it has significant limitations: it’s not cash flow (ignores CAPEX and working capital), it’s not profit (ignores real costs), and can be manipulated through accounting tricks.

How it Works

Calculating EBITDA starts from the income statement and applies adjustments to isolate operating performance.

Step-by-Step Calculation

Starting from Net Income:

Take Net Income from income statement
Add Interest Expense (financial costs)
Add Tax Expense
Add Depreciation (amortization of tangible assets: machinery, buildings)
Add Amortization (amortization of intangible assets: patents, goodwill)

Practical Example: SaaS Company

Simplified income statement (year 2025):

Revenue: $20 million
COGS: $4 million (servers, support)
Gross Profit: $16 million
Operating Expenses:
- R&D: $5 million
- Sales & Marketing: $6 million
- G&A (General & Administrative): $2 million
- Depreciation: $0.5 million
Operating Income (EBIT): $2.5 million
Interest Expense: $0.3 million
Earnings Before Tax (EBT): $2.2 million
Taxes (25%): $0.55 million
Net Income: $1.65 million

EBITDA Calculation: EBITDA = Net Income + Interest + Taxes + Depreciation + Amortization EBITDA = 1.65 + 0.3 + 0.55 + 0.5 + 0 = $3 million

EBITDA Margin = (3 / 20) × 100 = 15%

Alternatively, from the top: EBITDA = Revenue - COGS - OpEx (excluding D&A) EBITDA = 20 - 4 - (5 + 6 + 2) = $3 million

Adjusted EBITDA

Many companies, especially in M&A contexts or investor reporting, calculate Adjusted EBITDA, which excludes “one-time” or “non-recurring” items:

Stock-based compensation (SBC): equity compensation to employees (non-cash)
Restructuring costs: layoff costs, restructuring
Legal settlements: fines, extraordinary litigation
Acquisition costs: M&A expenses (due diligence, advisory)

Example: the company above has $0.5 million in SBC and $0.2 million in acquisition costs.

Adjusted EBITDA = 3 + 0.5 + 0.2 = $3.7 million Adjusted EBITDA Margin = (3.7 / 20) × 100 = 18.5%

Adjusted EBITDA is controversial: while it removes noise, it can be abused to “massage” numbers. Buffett famously said: “Does management think the tooth fairy pays for CAPEX?”

EBITDA vs Other Metrics

EBITDA vs EBIT (Earnings Before Interest and Taxes):

EBIT includes Depreciation & Amortization, so it’s lower than EBITDA
EBIT is closer to actual profit, EBITDA ignores asset wear-and-tear
Example: EBIT = $2.5M, EBITDA = $3M (difference = D&A = $0.5M)

EBITDA vs Operating Cash Flow (OCF):

OCF starts from Net Income but adds D&A (non-cash) and subtracts Working Capital changes (A/R, inventory, A/P) and CAPEX
OCF is actual cash generated, EBITDA is accounting metric
A company can have positive EBITDA but negative OCF if CAPEX is high or Working Capital grows

EBITDA vs Free Cash Flow (FCF):

FCF = OCF - CAPEX, represents cash available to shareholders and debtholders
FCF is the “gold standard” metric for valuations, EBITDA is a quick proxy
EBITDA overstates FCF if CAPEX is significant

EBITDA Multiples in Valuation

EBITDA is used to value companies through multiples: EV/EBITDA (Enterprise Value / EBITDA).

Formula: Enterprise Value = EBITDA × Industry Multiple

Where Enterprise Value (EV) = Market Cap + Debt - Cash

Typical multiples:

B2B SaaS: 8-15x EBITDA (growth companies), 4-8x (mature)
E-commerce: 5-10x EBITDA
Manufacturing: 4-8x EBITDA
Pre-IPO tech unicorns: 15-30x+ EBITDA (if profitable)

Example: SaaS company with $5 million EBITDA, 10x multiple, EV = $50 million.

Multiples vary with growth, margins, retention, market conditions. In 2020-2021 (bull market), inflated multiples. In 2023-2026 (capital scarce), compressed multiples.

Use Cases

M&A: Target Acquisition Valuation

An enterprise company considers acquiring a competitor with these financials:

Revenue: $30 million
EBITDA: $9 million (30% Margin)
Net Income: $4 million
Debt: $5 million
Cash: $2 million

Industry multiple: 8x EBITDA.

Valuation: Enterprise Value = $9M × 8 = $72 million Equity Value = EV - Debt + Cash = 72 - 5 + 2 = $69 million

If target asks for $80 million, it’s a 16% premium over market multiple. Acquirer must assess if synergies justify premium (e.g., cross-sell, cost savings).

Due diligence focuses on EBITDA quality: is it sustainable? Are there excluded one-time costs? Is revenue recurring or lumpy?

Private Equity: LBO (Leveraged Buyout)

A PE fund evaluates an LBO of a company with $15 million EBITDA. Strategy: acquire with debt, improve EBITDA, sell after 5 years.

Entry:

EV: $15M × 7x = $105 million
Debt financing: 60% ($63M)
Equity: 40% ($42M)

Exit (after 5 years):

EBITDA grown to $22M (8% CAGR)
Exit multiple: 8x (improved market)
Exit EV: $22M × 8 = $176 million
Debt repaid: $30M remaining
Equity value: $176 - 30 = $146 million

ROI for PE: ($146 - $42) / $42 × 100 = 248% over 5 years, 28% annualized.

This strategy depends on EBITDA growth (operational improvement, add-ons) and multiple expansion.

SaaS Startup: Tracking Toward Profitability

A Series B SaaS startup tracking for Series C must demonstrate path to profitability. Metrics:

Year 1 (current):

ARR: $10 million
EBITDA: -$2 million (-20% Margin, still investing)
Rule of 40: Growth 80% + Margin -20% = 60% (excellent)

Year 2 (target):

ARR: $16 million (60% growth)
EBITDA: -$1 million (-6% Margin)
Rule of 40: 60% + (-6%) = 54%

Year 3 (target):

ARR: $24 million (50% growth)
EBITDA: +$2 million (+8% Margin)
Rule of 40: 50% + 8% = 58%

This trajectory demonstrates discipline: scaling revenue while controlling losses, trending toward positive EBITDA. Series C investors evaluate based on this path.

E-commerce: Operational Benchmarking

A DTC (Direct-to-Consumer) e-commerce company compares EBITDA Margin with competitors:

Company A (ours):

Revenue: $50 million
EBITDA: $5 million (10% Margin)

Competitor B:

Revenue: $50 million
EBITDA: $7.5 million (15% Margin)

5% margin gap = $2.5 million EBITDA left on the table. Drill-down analysis:

Cost structure comparison:

COGS: A = $30M (60%), B = $27.5M (55%). B has better supplier economics.
Marketing: A = $10M (20%), B = $9M (18%). B has more efficient CAC.
Logistics: A = $3M (6%), B = $2.5M (5%). B has more efficient fulfillment.

Action plan: negotiate COGS, optimize CAC, improve logistics to close gap.

Corporate: Business Unit Evaluation

A multi-business corporation evaluates performance of 3 divisions:

Division A (Cloud Services):

Revenue: $100M, EBITDA: $35M, 35% Margin

Division B (Hardware):

Revenue: $150M, EBITDA: $15M, 10% Margin

Division C (Consulting):

Revenue: $80M, EBITDA: $24M, 30% Margin

Divisions A and C are high-margin, strategic keepers. Division B is low-margin, candidate for divestiture or spin-off. Management considers selling B at 8x EBITDA ($120M) and reinvesting in A/C.

Decision based on ROIC (Return on Invested Capital) and strategic fit, but EBITDA Margin is initial trigger.

Practical Considerations

EBITDA Limitations

1. EBITDA is not Cash Flow: The most common mistake is confusing EBITDA with cash generated. EBITDA ignores:

CAPEX: investments in machinery, tech, infrastructure (can be enormous)
Working Capital: if revenue grows, A/R and inventory grow, absorbing cash
Debt payments: principal repayment doesn’t appear in EBITDA

Example: manufacturing company with $10M EBITDA but $8M annual CAPEX has only $2M available FCF.

2. Depreciation is a real cost: Even if non-cash, depreciation reflects wear-and-tear. Ignoring it means ignoring that assets need replacement. Warren Buffett: “Do you think CAPEX is optional?”

3. Adjusted EBITDA can be abused: Companies can exclude “one-time” costs that recur every year. Red flag: if adjustments exceed 10-15% of EBITDA, scrutinize carefully.

4. Limited comparability: EBITDA varies with accounting policies (revenue recognition, capitalization). Comparing companies in different jurisdictions requires caution.

EBITDA and Industry Specifics

SaaS: EBITDA Margin correlated with stage:

Early (ARR below $10M): Negative margin (-20% to -50%)
Growth (ARR $10-50M): -10% to +10% margin
Scale (ARR above $50M): +15% to +35% margin

Best-in-class public SaaS (Salesforce, ServiceNow): 30-40% margin.

Manufacturing: Typical margin 8-15%. Capital-intensive, high CAPEX, so significant EBITDA-FCF gap.

Retail/E-commerce: Low margin 3-10%. Competitive, thin margins, scale is critical.

Consulting/Services: High margin 20-40%. Asset-light, profitability driven by utilization rate.

EBITDA in Contract Negotiations

In M&A, price is often structured as “X times EBITDA”. Negotiations:

Earn-outs: portion of price tied to future EBITDA. Example: $50M upfront + $10M if Year 1 post-acquisition EBITDA exceeds $12M. Aligns incentives.

Working Capital adjustments: if Working Capital delivery is below target, price reduced. Stable EBITDA but deteriorated WC is a red flag.

Net Debt adjustments: EV based on EBITDA, but Equity Value adjusted for final Debt and Cash. Negotiate Debt definition (include leases? Earnouts?)

EBITDA and Debt Covenants

Bank covenants often based on EBITDA:

Debt/EBITDA ratio: max 3x or 4x. If exceeded, technical default.

Interest Coverage (EBITDA/Interest): min 3x or 4x. Must generate sufficient EBITDA to cover interest.

Example: company with $30M Debt, $10M EBITDA. Debt/EBITDA = 3x. If EBITDA drops to $7M, ratio rises to 4.3x, violates covenant. Bank can demand repayment or renegotiate terms.

This makes EBITDA critical for financial stability.

Common Misconceptions

”High EBITDA Means Healthy Company”

Positive EBITDA doesn’t guarantee financial health. A company can have strong EBITDA but:

Negative cash flow: if CAPEX is massive or Working Capital explodes
Imminent insolvency: if Debt is unsustainable (Debt/EBITDA above 6x)
Quality issues: EBITDA inflated by aggressive revenue recognition

Always view EBITDA in context: FCF, Balance Sheet, Cash Conversion Cycle.

Example: Pre-2019 WeWork reported positive “Community Adjusted EBITDA” excluding “building costs” (rent). This was absurd: rent was the main cost. Misleading EBITDA led to inflated valuation and collapse.

”EBITDA is Universally Comparable”

EBITDA enables comparisons, but it’s not plug-and-play. Variables:

Accounting standards: US GAAP vs IFRS differ on revenue recognition, lease accounting.

Business model: asset-light (SaaS) vs asset-heavy (manufacturing) have different EBITDA/FCF gaps.

Stage: growth companies sacrifice EBITDA for growth, mature companies optimize margin.

Always normalize for stage, industry, accounting before comparing.

”Adjusted EBITDA Only Removes Noise”

Adjusted EBITDA can be legitimate (excluding one-time M&A costs) or manipulative (excluding recurring SBC).

Red flags in Adjusted EBITDA:

Adjustments above 20% of EBITDA: too many “one-time” events?
SBC systematically excluded: SBC is real compensation, excluding it understates costs
“Growth investments” excluded: marketing isn’t one-time, it’s operational

Sophisticated investors reconstruct EBITDA from raw financials, ignore Adjusted if suspicious.

Profit Margin: EBITDA Margin is a type of operating profit margin
ROI: EBITDA is input for calculating return on investment
Burn Rate: negative EBITDA equals operating burn (excluding financing)
Unit Economics: aggregate EBITDA derives from scaled unit economics
ARR: recurring revenue metric correlates with EBITDA for SaaS businesses

Sources

Harvard Business Review (2009). How EBITDA Can Mislead
Investopedia. EBITDA: Earnings Before Interest, Taxes, Depreciation and Amortization
Damodaran, A. (2012). Investment Valuation: Tools and Techniques for Determining the Value of Any Asset
McKinsey & Company. Valuation: Measuring and Managing the Value of Companies
Buffett, W. (2002). Berkshire Hathaway Annual Letter. “EBITDA is not a measure of cash generation”