Subscribe to Blog ContentEBITDA stands for Earnings Before Interest, Taxes, Depreciation and Amortization. Some people incorrectly assume it’s another term for cash flow. EBITDA is the result of revenue minus expenses, but it doesn’t take into consideration taxes, depreciation and amortization. EBITDA overlooks cash needed for working capital and replacing costly items.
EBITDA can provide a good idea of a company’s financial performance, but not its cash earnings or free cash flow (FCF). Some accountants might use EBITDA to make a business’ earnings look better than it actually is. On the flip side, EBITDA can also give the impression a company is cheaper than it is when analyzing the stock price multiples instead of bottom-line earnings.
For example, a startup provides a service to repair widgets. Its investor wants to know how much money the company made in a given day. The investor isn’t thinking about Widget Service, Inc’s debts, assets and all those complicated figures when asking the question. They want to know how much money they made. That’s the EBITDA.
So based on the example, you have an idea how the business is doing in selling a product or providing a service. The investors might ask for this number on a daily, weekly or monthly basis to see how that number is moving. That data gives them an idea of how much the product or service is wanted or needed.
Let’s say you earn $5,000 per paycheck. You don’t go out and spend it all on a computer as soon as your paycheck comes in. You have bills to pay (the fixed expenses) including rent (or mortgage), car payments, electricity, water, cable, phone and so on. What about groceries? If you spend it all on a computer, you can’t pay for anything or you rack up serious credit card debt that will take a while to pay off if you keep spending $5000 on things you don’t pay for every paycheck.
But EBITDA doesn’t help them ensure the company has cash available to pay for supplies, debts, capital expenditures, and fixed expenses. EBITDA ignores capital expenditures (CAPEX), an important number that shows the value of a business. Capital expenditures could include buying fixed assets, readying an asset for use, or anything having to do with equipment, property, or buildings.
The lesson here is to know your cash flow and don’t rely on EBITDA alone. It’s a nice number to know, but not enough to tell your business’ story.
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