EBITDA, which stands for Earnings Before Interest, Taxes, Depreciation, and Amortization, is one of the most widely used metrics for measuring a business's operating profitability. It strips out non-cash charges and financing decisions to show how much a business earns from its core operations.
There are two routes to the same number.
From the top down (income statement order):
EBITDA = Revenue - Cost of Goods Sold - Operating Expenses (before D&A)
Starting from net income:
EBITDA = Net Income + Interest Expense + Taxes + Depreciation + Amortization
Both approaches produce the same figure when the books are accurate.
Interest: Different companies have different capital structures (some use debt, some use equity). Removing interest makes it easier to compare operating performance across companies regardless of how they are financed.
Taxes: Tax rates vary by jurisdiction, structure, and prior-year losses. Removing taxes focuses the comparison on business operations.
Depreciation and amortization: These are non-cash charges. They reduce reported income but do not represent cash leaving the business. EBITDA adds them back to approximate cash-generating ability.
Valuation: Private equity buyers and strategic acquirers commonly use EBITDA multiples to value businesses. A company with $2M in EBITDA in a sector trading at 6x would have an implied value of $12M.
Loan covenants: Lenders often set debt limits as a multiple of EBITDA (e.g., debt cannot exceed 3x EBITDA) and require minimum EBITDA coverage ratios.
Board reporting: EBITDA is a common metric in board decks because it isolates operating performance from capital structure noise.
EBITDA margin shows what percentage of revenue becomes EBITDA.
EBITDA Margin = EBITDA / Revenue
A business generating $5M in revenue with $1M in EBITDA has a 20% EBITDA margin. Margins vary widely by industry. SaaS businesses often target 20 to 40% at scale. Manufacturing businesses may operate at 10 to 15%.
EBITDA has real limitations.
It is not cash flow. Depreciation is added back, but capital expenditures are not subtracted. A capital-intensive business with high maintenance CapEx can look profitable on EBITDA while consuming significant cash.
It ignores working capital. If receivables are growing faster than revenue, cash generation is lower than EBITDA implies.
It can be manipulated. Aggressive add-backs and one-time expense adjustments can inflate "adjusted EBITDA" beyond what the business actually earns.
For these reasons, EBITDA works best as one metric among several, alongside free cash flow, gross margin, and net income.
