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Definition: EBITDA stands for Earnings before interest, tax and amortization.

Caculating EBITDA

EBITDA measures a company's operating performance. It is essentially net income with interest, taxes, depreciation, and amortization added back to it, and can be used to analyze and compare profitability between companies and industries because it eliminates the effects of tax, financing and accounting decisions.

To calculate EBITDA, one must add depreciation and amortization to a firm's operating income. Formula:

EBITDA = EBIT + Depreciation + Amortization

Analysis with EBITDA

EBIDTA enables analysts to exclude the impacts of non-operating activities and focus on the outcome of operating decisions. Non-operating activities include interest expenses, tax rates, and large non-cash items such as depreciation and amortization.

By removing the non-operating effects, EBITDA gives investors the ability to focus on the profitability of their operations. This type of analysis is particularly important when comparing similar companies across a single industry for example.

Limitations of EBITDA

The EBITDA calculation can be deceptive if it is not applied correctly - particularly for firms with massive debt - because it will almost always be higher than reported net income.

EBITDA isn't regulated by GAAP. Therefore, investors are at the discretion of the company to decide what will be, and what will not be, included in the calculation.

When analyzing a firm's EBITDA, one should remember to factor in other items, for example: capital expenditures, changes in working capital requirements, debt payments, and net income.