What Is EBITDA? How It Works and Why Investors Should Be Careful
Last Updated on 1 month ago by Antony C.
EBITDA is a financial metric you will often see when analysing companies. It can be useful for understanding how a business is performing, doing fundamental analysis, but personally, it is not one of metrics I will choose to use.
The reason is simple. EBITDA removes several important expenses, which can sometimes make a company look healthier than it really is.
So let’s look at what EBITDA actually means, how to calculate it, and how I think investors should use it.
What Is EBITDA?
EBITDA stands for Earnings Before Interest, Taxes, Depreciation, and Amortization.
It looks at a company’s earnings before these four items are deducted:
| Term | Simple Meaning |
|---|---|
| Interest | Cost of borrowing money |
| Taxes | Income taxes paid by the company |
| Depreciation | Accounting expense for physical assets such as equipment |
| Amortization | Similar to depreciation, usually for intangible assets |
By removing these expenses, EBITDA gives investors another way to look at the company’s underlying operating performance.
It can also make it easier to compare similar companies with different debt levels, tax situations, or asset structures.
But there is one thing I want to make clear early:
EBITDA is not cash flow.
A company can report strong EBITDA while generating very little actual cash.
EBITDA is also considered a non-GAAP financial measure in the US, meaning it is not a standard profit figure under generally accepted accounting principles. Companies that report it normally reconcile it back to a GAAP measure such as net income.
How to Calculate EBITDA
One of the simplest ways to calculate EBITDA is:
EBITDA = Net Income + Interest + Taxes + Depreciation + Amortization
You start with the company’s net profit and add those expenses back.
Simple EBITDA Example
Let’s say a company reports:
| Item | Amount |
|---|---|
| Item | Amount |
| Net Income | $100 million |
| Interest | $20 million |
| Taxes | $30 million |
| Depreciation | $35 million |
| Amortization | $15 million |
The calculation would be:
- EBITDA = $100m + $20m + $30m + $35m + $15m
- EBITDA = $200 million
So while the company reported $100 million in net income, its EBITDA was $200 million.
That does not mean it generated $200 million in free cash.
It simply means earnings were $200 million before those particular expenses were deducted.
How to Interpret EBITDA
Unlike ROE or profit margin, EBITDA is normally shown as a dollar amount.
Because of this, there is no universal number that tells us whether EBITDA is “good.”
A $50 million EBITDA might be excellent for a small business but very poor for a huge multinational company.
Instead, I look at EBITDA in context.
Positive or Negative EBITDA
- A positive EBITDA means the company is profitable before interest, taxes, depreciation, and amortization.
- A negative EBITDA means the company is losing money even before these expenses are taken into account.
Generally, I would be more cautious with a company that consistently reports negative EBITDA.
However, positive EBITDA does not automatically mean the company is financially strong.
Growing or Falling EBITDA
The trend is often more useful than one single number.
- If EBITDA has been increasing steadily over several years, it may suggest that the company’s operating performance is improving.
- If EBITDA keeps falling, I would want to understand why.
I also like comparing EBITDA growth with revenue and cash flow.
If EBITDA keeps rising while actual cash flow is falling, that is something I would investigate further.
EBITDA Margin
Another useful way to compare companies is through EBITDA margin.
The formula is:
EBITDA Margin = EBITDA ÷ Revenue × 100
For example, if a company generates:
- Revenue: $1 billion
- EBITDA: $200 million
Its EBITDA margin is: $200 million ÷ $1 billion × 100 = 20%
This means the company produces $0.20 of EBITDA for every $1 of revenue.
Generally, a higher margin is better, but there is no universal “good” EBITDA margin.
Different industries operate very differently, so I would compare companies within the same industry and look at how their margins change over time.
Why Do Investors Use EBITDA?
Despite its weaknesses, EBITDA can still be useful.
One reason is comparison.
Imagine two similar companies. One uses a lot of debt while the other has very little debt. The highly leveraged company will probably pay much more interest, which reduces its net profit.
By removing interest, EBITDA lets us compare their operations before considering how each business is financed.
Investors also use EBITDA to:
- Compare operating performance between similar companies
- Track whether profitability is improving
- Compare EBITDA margins
- Analyse companies with different capital structures
Companies themselves commonly present EBITDA and Adjusted EBITDA as additional measures of operating performance, while noting that they should not replace standard financial measures such as net income.
So I don’t think EBITDA is useless.
I just wouldn’t rely on it alone.
Problems and Limitations of EBITDA
This is where investors need to be careful.
1. EBITDA Is Not Cash Flow
This is probably the biggest issue for me.
EBITDA does not properly account for things such as:
- Capital expenditure
- Changes in inventory
- Money customers still owe the company
- Interest payments
- Taxes
All these things affect the actual cash available to the business.
A company can therefore show impressive EBITDA while having weak cash flow.
2. It Ignores Capital Expenditure
Imagine a company owns factories filled with expensive machinery.
- Those machines eventually wear out.
- The company will need to repair or replace them, and that costs real money.
EBITDA adds depreciation back to earnings. This can be useful for some comparisons, but it can also make a capital-intensive business appear more profitable than it really is.
Warren Buffett has been particularly critical of EBITDA.
In Berkshire Hathaway’s 2000 shareholder letter, he asked whether management thought the “tooth fairy pays for capital expenditures.”
His point is easy to understand.
Depreciation may not be cash leaving the company today, but the assets being depreciated cost real money and may eventually need replacing.
This is one reason I am cautious when looking at EBITDA for businesses that require lots of equipment, property, vehicles, or infrastructure.
3. It Ignores Interest and Debt Costs
EBITDA also removes interest expenses.
Again, that makes comparing operations easier.
But a company’s debt does not magically disappear.
Suppose two companies each report $100 million in EBITDA.
One has very little debt while the other has borrowed billions and needs to make large interest payments every year.
Their EBITDA might look similar, but their financial risk is very different.
So whenever I look at EBITDA, I also want to know how much debt the company carries.
4. Adjusted EBITDA Can Remove Even More Expenses
Then there is Adjusted EBITDA.
Adjusted EBITDA starts with EBITDA and removes additional expenses that management believes investors should exclude.
These might include:
- Stock-based compensation
- Restructuring costs
- Impairment charges
- Acquisition expenses
- Legal settlements
- Other supposedly one-off expenses
Some adjustments may be reasonable.
The problem comes when a company keeps adding back expense after expense.
Real company filings show that Adjusted EBITDA can exclude many additional items beyond normal interest, taxes, depreciation, and amortization.
If I see many adjustments, I like to check exactly what management is removing.
And if a “one-off” expense appears every year, I would question whether it is really one-off.
EBITDA vs Other Financial Metrics
EBITDA is only one way to look at a business.
Here is how it compares with a few other common metrics:
| Metric | What It Mainly Shows |
|---|---|
| EBITDA | Earnings before interest, taxes, depreciation, and amortization |
| EBIT | Operating earnings after depreciation and amortization |
| Operating Cash Flow | Cash generated from normal business operations |
| Free Cash Flow | Cash remaining after operating needs and capital expenditure |
Personally, I tend to find operating cash flow and free cash flow more useful when I want to understand whether a company is actually generating cash.
After all, businesses need real cash to pay dividends, reduce debt, reinvest, and grow.
EBITDA cannot tell me that on its own.
How I Personally Use EBITDA
I don’t ignore EBITDA completely.
If a company reports it, I may use it to understand operating trends or compare the business with similar companies.
But I treat EBITDA as a supporting metric, not the final answer.
When EBITDA looks good, I still want to check:
- Is the company generating healthy cash flow?
- How much capital expenditure does it need?
- Does it have a lot of debt?
- Are EBITDA margins improving?
- Is management making lots of adjustments?
For me, EBITDA gives you one view of a company’s performance.
It just doesn’t give you the whole picture.
Frequently Asked Questions
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Antony C. is a Singaporean dividend investor focused on building passive income through REITs, ETFs, and Dividend Stocks. With 15+ years of experience investing in Singapore, Hong Kong, and China markets, he founded IncomeBuddies.com to share practical wealth-building strategies tested in his own portfolio since 2008. His expertise has been featured in Yahoo Finance, Nasdaq, and NFAA, and he’s the published book author of "Start Small, Dream Big".