EBITDA

How it's calculated

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

Or working from the income statement top:

EBITDA = Operating Income + Depreciation + Amortization

The two should produce the same number, modulo non-operating items.

EBITDA is intentionally above-the-line of three sets of decisions:

• Capital structure (interest paid on debt) — adding it back makes leveraged and unleveraged companies comparable.
• Tax position — adding back taxes makes companies in different tax jurisdictions or with different tax-loss positions comparable.
• Asset accounting (depreciation and amortization) — adding back these non-cash items makes asset-heavy and asset-light companies comparable.

Why EBITDA gets used

A few legitimate reasons:

• Cross-company comparison. Two companies with identical operations but different capital structures (one is debt-financed, one is equity-financed) will have very different net incomes but similar EBITDA. EBITDA strips out the financing decision.
• M&A valuation. Acquirers care about the cash-generating capability of the operations they're buying. EBITDA approximates that better than net income for the buyer's perspective.
• Cash flow proxy. For most operating businesses, EBITDA roughly tracks operating cash flow, which is what matters for debt service and dividends.

EV/EBITDA is one of the most-cited valuation multiples, especially in private equity and M&A.

The Buffett critique

Warren Buffett (and Charlie Munger before him) have been famously dismissive of EBITDA. Their argument:

• Depreciation is real. Equipment wears out and must be replaced. Adding back depreciation pretends future capital expenditure won't happen, when in fact it will.
• Stock-based compensation. Many companies present "adjusted EBITDA" excluding stock-based comp. But equity issued to employees genuinely dilutes shareholders.
• One-time items. Companies' definitions of what's "non-recurring" tend to be aggressive in their favor.

Buffett's preferred measure is "owner earnings" — net income plus depreciation minus normalized capital expenditures — which acknowledges that some maintenance capex is required to keep the business running, and treats only the residual as truly available to shareholders.

When EBITDA is most reasonable

EBITDA works best for:

• Capital-intensive businesses with predictable maintenance needs. Telecom infrastructure, utilities, real estate. The depreciation is real, but it's also predictable and can be modeled separately.
• Businesses being valued for acquisition. The acquirer is taking over the operations and will assess capex needs themselves.
• Comparing across leverage levels. Two similar operating businesses with very different debt loads.

When EBITDA is misleading

EBITDA fails badly when:

• Capex is large and ongoing. A retailer's reported EBITDA is much higher than its true cash-generating capacity if maintenance capex is heavy.
• Stock-based compensation is significant. Many software companies with strong "adjusted EBITDA" margins are paying employees largely in stock, with real economic dilution.
• Depreciation reflects rapid economic obsolescence. Tech equipment, vehicles, and similar assets need real replacement; the GAAP depreciation is often a reasonable approximation of that real cost.

For companies in these buckets, free cash flow — operating cash flow minus capital expenditures — is a more honest measure of cash actually available to investors.

Common EBITDA-related metrics

• EBITDA margin = EBITDA / Revenue. Profitability before financing and accounting decisions.
• EV/EBITDA = Enterprise Value / EBITDA. Valuation multiple; alternative to P/E that's invariant to leverage.
• Debt/EBITDA = Total Debt / EBITDA. How many years of EBITDA would be needed to retire all debt. Below 3x = conservative; above 5x = aggressive.
• EBITDA-to-interest = EBITDA / Interest Expense. How comfortably the business covers debt service.

Bottom line

EBITDA is a useful tool in the analyst's toolkit but not a substitute for understanding the underlying business. The most common error is treating reported EBITDA as if it were free cash flow — it isn't, and the gap can be enormous in capital-intensive businesses or those with significant stock-based compensation.

The boring honest framing: EBITDA tells you about operating performance before financing and accounting choices; cash flow tells you about cash actually generated; net income tells you about reported profit. All three matter; none is sufficient alone.