Tuesday, October 11, 2011

Back to Basics: EBITDA

EBITDA is the acronym for Earnings Before Interest, Taxes, Depreciation and Amortization. EBITDA represents (basically) the operating cash flow of the company.  It is a good indication of the cash being generated by the company’s operations and is readily apparent in the P&L (as long as there is sufficient detail provided).  Banks and others use this indicator as a barometer of the company’s ability to meet its obligations for loans or future operational requirements.  Management should use EBITDA as an indication of its effectiveness in producing acceptable cash returns on the company’s operating activities.

There are two limitations that reduce the usefulness of EBITDA as a tool for closely managing the company’s operations.  Since EBITDA only provides information related to the P&L, any activity on the balance sheet such as changes in accounts receivable, accounts payable, fixed assets, debt, etc. are not indicated.  Therefore, large swings in cash will be missed if you are only looking at EBITDA as a cash management tool.  Also, as with the Statement of Cash Flows, EBITDA is only available when the P&L is produced making it unusable for managing the daily or weekly business requirements.