EBITDA is a common acronym in the business world, and as a journalist, it is important to understand not only what it means but how to interpret and give context to it. Here are some tips to do just that.
What does it mean and where does it come from?
EBITDA stands for Earnings Before Interest, Taxes, Depreciation, and Amortization. This measure is frequently presented as an indicator of a company’s performance, and an alternative to the more common measure of net profit, or what’s left over after deducting a company’s expenses from revenue. Companies with a heavy debt load or lots of fixed assets tend to prefer EBITDA over net profit as the former paints a more favorable picture.
Here’s how it breaks down:
- Interest: This cost depends on the financial structure of the company and how much debt it currently holds.
- Taxes: Varies by location of the company.
- Depreciation: Takes into account the decline in value of fixed assets over time, such as vehicles and equipment, as they’re used in the company’s operations.
- Amortization: Similar to depreciation, but for other assets including intangible ones. Depreciation and amortization are non-cash expenses, meaning they are considered costs of doing business but don’t require cash payments.
EBITDA can be misleading
Although this measure is commonly reported by companies, that doesn’t necessarily mean that it is the best measure of a company’s financial performance. Even Warren Buffett called the figure meaningless and often misleading in the early 2000s because it ignores the legitimate costs of doing business. As he noted, “taxes are a real expense” and disregarding those costs allows a company to make its financial situation appear better than it may actually be.
EBITDA figures commonly ignore the cost of assets and even stock-based compensation, which is a major expense in many tech companies and thus why many choose to put those figures out in front, such as Uber who used the term 42 times in their 2020 earnings report.
Even though experienced investors may be aware that EBITDA may not always be what it seems to be, that doesn’t mean journalists can assume everyone knows to approach these numbers with caution.
What to look out for and where to give context
You will not find EBITDA directly listed on an income statement because it is not recognized as a generally accepted accounting principle (GAAP). In fact, the SEC requires public companies to show how they came up with their EBITDA figures and forbids them from reporting it on a per-share basis.
There is no standardized formula for calculating EBITDA, and thus the formula can vary widely from company to company. WeWork infamously used creative financing to come up with their “community adjusted EBITDA,” which included the costs for basic business expenses such as marketing, rent, staffing, development and administrative costs — basically, all the costs of running their business.
A common red flag to be on the lookout for is when a company suddenly starts featuring its EBITDA when they haven’t regularly done so in the past. This could be an indication that they are trying to de-emphasize something that may be hurting their bottom line, which may be worth digging into.
Always remember, EBITDA should never be used as a silo measure. Context is important and other figures are necessary to understand the overall financial health of a company.
If you want to learn more about financial statements, check out our free e-course “Covering Financials.”
