Why We Use EBITDA
EBITDA, or Earnings Before Interest, Taxes, Depreciation and Amortization, doesn't get the credit it deserves. Some people even nickname it and call it Bullshit Earnings. Reputable investors such as Warren Buffett have been highly critical of the use of EBIDTA by managements. They ask who pays the capital expenditures? The tooth fairy?
EBITDA is a Measurement Tool
Witty comments aside, when it comes down to it all, EBITDA is a mear measurement tool. Just like we measure temperature and humidity, we can use EBITDA to measure and compare the profitability of operating units. Nothing more, nothing less. As with any other tool, you can use it in a good way and use it in a bad way. But what is the good way, you might rightfully ask.
EBITDA is an operating metric. It tells you something about the operations of a company. The main benefit of EBIDTA is that it is agnostic about different capital structures. Consider the following:
- A company that carries debt, will pay interest. The interest payments will skew the profitability of the operations compared with a company with no debt, on a net profit basis.
- Interest payments are before taxes, therefore they will affect the taxation of the operation. Also, companies operating in different geographic regions might be subject to different tax rates.
- Depreciation and amortization are accounting numbers (as opposed to cash flow numbers). As such, they are subject to all sorts of fungibility and legacy issues, that can affect these values and distort any comparison on the operating profitability of two competing companies.