I know right, you hear the acronym being thrown around left right and centre in the startup world. The number of times I’ve had someone try to explain it to me and been left more confused than before I asked. Look no further. We’re going to break it down for you in simple terms:
EBITDA is : “earnings before interest, taxes, depreciation, and amortization.”
Generally speaking, investors use EBITDA when they want to see a company’s performance without all the deductions like tax. Despite it’s limitations, EBITDA can be helpful when trying to get a snapshot of a company’s raw earnings before dissecting all of the nasties like financing and upkeep.
However, it’s regularly criticised for it’s shallow and ‘plucked’ approach. Our favourite quote comes from Charlie Munger (Warren Buffet’s longtime business partner):
“I think that, every time you see the word EBITDA, you should substitute the word ‘bullshit’ earnings.”
WHY IT’S LIMITED:
When you look at a balance sheet, you’ll find net profit. Although NP is ultimately how much money a company is making right now, it’s determined by expenses that may look to reduce drastically over the coming months/years therefore validating EBITDA.
EBITDA though can easily hide all sorts of financial problems that a company maybe facing. Here are some important potential issues to think about.
Interest – Capital loans have interest rates that can vary massively! If interest repayments are monster then a company that may have an enticing EBITDA may have slim chances of ever making any cash.
Taxes – Taxes on gains won’t affect an EBITDA report. Without gaining a full handle on the structure of the organisation and where it’s getting taxed how are you meant to understand the true earning power?
Depreciation – Without understanding the true depreciation of a companies assets, how can investors determine the real value of these assets?
Amortization – Again, if a company has capital loans, EBITDA will bypass how much the monthly loan repayments are and if these are bigger than sales revenues, you’re in trouble.