What is EBITDA?

EBITDA stands for Earnings Before Interest, Taxes, Depreciation, and Amortization. It is a financial metric used to evaluate a company’s operating performance. Ideally, it allows you to see how much money the business makes purely from its operations, ignoring the impact of its capital structure, tax jurisdiction, and non-cash accounting items.

For a founder, EBITDA serves as a way to strip down the numbers to the core engine of the business. It answers a specific question. If we didn’t have to pay the bank, the government, or account for the aging of our equipment, is this business actually profitable?

It is widely used in valuation. Investors often speak in terms of “EBITDA multiples.” For example, a company might be sold for “10x EBITDA.” This makes it a critical number to understand if you plan to sell your company or raise late-stage private equity.

To calculate EBITDA, you start with your Net Income (the bottom line) and add back specific costs.

• Interest: The cost of your debt. Adding this back allows you to compare a company with a lot of loans to a company with no loans.
• Taxes: Tax rates vary by country and state. Adding this back focuses on the business, not the government.
• Depreciation: The accounting method of allocating the cost of a tangible asset over its useful life. It is a non-cash expense.

Amortization: Similar to depreciation but for intangible assets. For tech startups, this often relates to intellectual property or software development costs.

By adding these back, you get a clearer picture of the cash generation potential of the core operations.

The biggest mistake a founder can make is assuming EBITDA is synonymous with cash flow. It is not. In fact, relying solely on EBITDA can be dangerous.

EBITDA ignores Capital Expenditures (CapEx). If you run a delivery business and need to buy new trucks every three years, that is a real cash cost. EBITDA ignores that cost. Warren Buffett famously criticized this metric, asking, “Does management think the tooth fairy pays for capital expenditures?”

It also ignores changes in working capital. If you have a million dollars in EBITDA but all your cash is tied up in inventory that isn’t selling, you can still go bankrupt.

For early-stage startups, EBITDA is often irrelevant. You are likely burning cash, not generating earnings. Your focus should be on unit economics and growth.

However, as a company matures, EBITDA becomes the standard for health. It is particularly useful when comparing companies in the same industry.

If Company A has a Net Income of one million dollars and Company B has a Net Income of five hundred thousand dollars, Company A looks better. But if you find out Company B is paying massive interest on a loan that will be paid off next year, their EBITDA might actually be higher. This reveals that Company B might actually have the stronger operational engine once the debt is cleared.

Use EBITDA to measure efficiency, but use the Cash Flow Statement to measure survival.