EBITDA - Earnings Before Interest, Taxes, Depreciation and Amortization
Categories: Accounting, Metrics, Investing, Stocks
Officially, EBITDA is an earnings measure, with the letters standing for "Earnings Before Interest, Taxes, Depreciation and Amortization." Its focus is to try and divine the cash flow that a company in a theoretical financial vacuum would produce if you ignored (and yes, you can't in real life) the amount of debt it has, the cost of the factory it bought 7 years ago, its taxes, and other stuff. EBITDA is a kind of proxy for operating cash flow (and it's not a GAAP term). Unofficially, it's a way for a company to convince you it's not losing money when, in fact, often...it's losing money. Cash-money as opposed to accounting earnings.
Companies are required to report their quarterly results using certain accountings standards. These are called GAAP, or "Generally Accepted Accounting Principles." (The chance that a company is trying to get away with a little something increases substantially with each impenetrable acronym a sentence has, as in "The Q1 non-GAAP EBITDA outpaced expectations on a QoQ basis.") This GAAP accounting includes things like taxes and interest, and all the other things the EBITDA letters stand for that only a CPA and/or your grandpa understands completely.
The idea behind EBITDA (pronounced, by the way, as "ee-bit-da," or a little like how a Cajun might say "He's a big dog") is the company saying "See, if we didn't have to pay taxes, or pay the interest on the loans we took out to buy all that equipment, or if the accountants didn't make us take provisions for depreciation on that equipment or amortize anything, this is how much we would make." The goal is to show that the underlying business is sound; positive EBITDA shows that the company generates more cash on an ongoing basis than it spends on its operations.
Of course, in reality, companies do pay taxes and interest, and they need to do all the accounting stuff. It's like telling your spouse, "hey, if there hadn't been any traffic, and I didn't have to stop for gas, and I didn't catch those last three red lights, I would have been on time to dinner." That would be DTBTGRL, or "Dinner Time Before Traffic, Gas, or Red Lights." We'd pronounce that as "dit-bit-grill," but that's just a suggestion.
Related or Semi-related Video
Finance: What is Debt-to-EBITDA?58 Views
finance a la shmoop what is the debt to EBITDA ratio alright people well
anytime you see that to in there a pretty good chance we're dealing with a [Person writes ratio on chalkboard]
ratio and yeah this one's a ratio that compares what a company owes in debt to
its EBITDA or earnings before interest taxes depreciation and amortization
otherwise lovingly known on Wall Street as cash flow like the cash it produces [Cash falls from sky]
alright well the numbers used by bankers and investors to see how leveraged is a
company is and evaluate its creditworthiness the higher the number
the more likely it is that a company will struggle to pay up its debt.. Well,
let's use a couple of practical examples here, a demo;
if your friend Deb wants
to borrow five grand from you maybe Deb just doesn't want her pops to
know she you know dented the car she's not the best driver in the world and
Deb's a two on the friend reliability scale like you totally trust her and [Deb moving side to side on reliability scale]
she's a lawyer and makes hundreds of thousands of dollars a year suing people
for stuff all right well after living expenses she has cash flow personally of
some fifty grand a year that she socks away in a mattress you know what she [Deb places cash under mattress]
sleeps on so you'd go ahead and make the loan to Deborah and you'd have no doubt
that she has the dough to pay you back your five grand the debt to EBITDA in
this situation five grand over 50 grand or one to ten or 0.1 very low debt to
EBITDA ratio there very safe bet she'll pay you back your five grand
well this logic applies to loaning companies money as well the five grand [Man discussing loans outside Amazon building]
in debt is quote money good unquote and you don't lose sleep over loaning them
that money if they have good credit and low debt to EBITDA doubt ratios right they
have more than enough cash flow to cover that debt well so then what's bad debt
to EBITDA ratio like what does that look like well it's when you have debt
of more than three or four five times cash flow some companies go even higher [Bad debt-to-EBITDA ratio example]
so if whatever dot-com has 50 million dollars in cash flow but three hundred
million dollars in debt that's a really high debt to EBITDA ratio of three
hundred over fifty or six to one or you just say
6x if that debt costs a 8% a year to rent well then the total cost just to pay
interest is 24 mil or almost half of all the company's cash flow for the entire
company and remember they got to be paying down the principal as they go [Whatever.com's cash flow debt]
along as well so it's a huge percentage of their cash flow just goes to the bank
should whatever com stumble and maybe you don't know interest rates go up as
well well then things could get ugly really fast and yes even uglier than [Deb driving a car in a storm]
this so yeah you want low debt to EBITDA ratios not high ones unless you're a
real dice roller there [Debt laid in hospital bed]