What is EBITDA? Definition and Formula

EBITDA is one of the most widely used — and most debated — financial metrics in business and investing. It's a measure of a company's operating profitability that strips out several items to focus on the underlying performance of the business itself. This guide explains what EBITDA is, how it's calculated, what it's used for, its limitations, and why it matters — in plain language. It's a core concept in corporate finance and investment analysis, relevant to ACCA and CIMA study.

What is EBITDA?

EBITDA stands for Earnings Before Interest, Taxes, Depreciation and Amortisation. As the name says, it's a company's earnings before deducting four specific items: interest (the cost of debt financing), taxes, and depreciation and amortisation (the non-cash charges for using up tangible and intangible assets). The idea is to measure a company's operating profitability — how much the core business earns — before the effects of how it's financed, the tax regime it operates under, and its accounting choices on asset write-downs.

How EBITDA is calculated

EBITDA can be calculated in two equivalent ways:

• Starting from net profit: Net profit + interest + taxes + depreciation + amortisation.
• Starting from operating profit: Operating profit + depreciation + amortisation.

For example, if a company has operating profit of £800,000 and depreciation and amortisation of £200,000, its EBITDA is £1,000,000. Either method arrives at a figure that reflects the cash-generating capacity of the operating business, before the items EBITDA deliberately excludes.

What EBITDA is used for

EBITDA is popular for a few reasons:

• Comparing companies. By stripping out financing, tax and depreciation policies, EBITDA allows a more like-for-like comparison of the operating performance of different companies — even those with different capital structures, tax positions or asset bases.
• Valuation. The EV/EBITDA multiple (enterprise value divided by EBITDA) is one of the most common ways to value companies, especially in mergers and acquisitions.
• A proxy for cash flow. Because it adds back the non-cash depreciation and amortisation charges, EBITDA is often used as a rough indicator of operating cash generation.

EBITDA vs operating profit and net profit

It helps to see where EBITDA sits relative to other profit measures. Operating profit is profit from core operations after charging depreciation and amortisation but before interest and tax. Net profit (the bottom line) is what's left after everything — including interest and tax. EBITDA sits above both, adding depreciation and amortisation back to operating profit. So EBITDA will always be the highest of the three figures, which is part of why companies like to highlight it — and part of why readers should treat it with care.

The limitations of EBITDA

EBITDA is also heavily criticised, and it's important to understand why. By excluding depreciation and amortisation, it ignores the very real cost of using up assets — a capital-intensive company genuinely has to spend money replacing equipment, and EBITDA conveniently overlooks this. It also ignores interest, which can flatter highly-indebted companies, and it doesn't account for changes in working capital or for capital expenditure, so it's an imperfect proxy for cash flow. Crucially, EBITDA is not a defined measure under accounting standards, which gives companies latitude in how they present it — and it can be used to make results look better than they are. For all these reasons, it should never be looked at in isolation.

Why EBITDA matters

EBITDA matters because it's so widely used — in company analysis, valuation and lending — so understanding it is essential, including both what it usefully shows and what it conveniently hides. Used carefully, alongside other measures (like actual cash flow and net profit), EBITDA is a useful lens on operating performance. Used uncritically, it can mislead. For anyone in finance, knowing how to interpret EBITDA — and when to be wary of it — is a valuable, practical skill.

Frequently asked questions

What is EBITDA?

Earnings Before Interest, Taxes, Depreciation and Amortisation — a measure of a company's operating profitability before the effects of financing, tax and non-cash asset charges.

How is EBITDA calculated?

Net profit plus interest, taxes, depreciation and amortisation; or, equivalently, operating profit plus depreciation and amortisation.

What is EBITDA used for?

Comparing the operating performance of different companies, valuation (via the EV/EBITDA multiple), and as a rough proxy for operating cash generation in a business.

What are the criticisms of EBITDA?

It ignores the real cost of using up assets (depreciation), interest and capital expenditure, isn't defined by accounting standards, and can be used to flatter capital-intensive or highly-indebted companies.

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