EBITDA Explained for First-Time Investors
Introduction
Heard the term EBITDA and tuned out? You’re not alone. This confusing acronym actually holds some of the most important clues about how financially healthy a business really is. Let’s break it down without the jargon.
What Does EBITDA Mean?
EBITDA Stands for ‘Earnings Before Interest, Taxes, Depreciation, and Amortisation’. In plain English, it’s a measure of how much money a company earns from its core operations before factoring in government taxes, debt repayments, or accounting adjustments.
Think of it as the “pure” profit number.
Example: The Fitness Studio
Imagine a boutique fitness studio that makes $1 million a year from memberships, training, and merchandise. After covering salaries, rent, equipment upkeep, and marketing, its operating costs total $600,000. That leaves an EBITDA of $400,000, showing how profitable the studio’s core operations are before taxes or loan repayments.
For investors, this number makes it clear the studio is more than just popular with clients - it’s financially strong and built for growth.
Why Use EBITDA and What’s it Useful For?
It gives a clearer picture of how profitable a company is from its core operations -ignoring the noise.
Company Valuations: If we want to compare companies from different industries, such as Beyond Meat and ELF, we can use EBITDA to see which one is more profitable. Because EBITDA focuses only on earnings from a company’s main operations, it strips away the effects of taxes, debt, and other financial factors.
Investors often take it further by looking at the EV/EBITDA ratio, which basically compares what a company is worth to how much cash it makes from its main business. Think of it like checking if a company is overpriced or a bargain based on the money it actually brings in. This makes it easier to compare totally different companies, since you’re seeing how much bang you get for each buck of earnings."
Investment Decisions: EBITDA shows how efficiently a company runs its core operations, without being influenced by taxes, debt, or financial strategies that can make profits look higher or lower than they really are. This makes it easier to compare companies and understand how well they are performing in their day-to-day business.
Analysts and investors use EBITDA as a key measure of business health because it strips out the impact of debt and taxes, giving a clearer view of how profitable the company’s operations truly are.
Growth Tracking: EBITDA is not only used to value businesses during acquisitions or investment decisions, but also to measure how a company’s core operations are performing over time. It shows how much a business truly earns from its main activities, making it easier to judge progress toward profitability. Startups and growing companies often highlight EBITDA to demonstrate that, even while they are investing heavily in expansion or product development, their underlying operations are becoming more efficient and moving closer to profits."
It’s especially useful for start-ups or global businesses operating in countries with very different tax systems.
Formula: How to calculate it
There are two common ways to calculate EBITDA:
1. Starting from Revenue:
EBITDA = Revenue – Operating Expenses (excluding interest, taxes, depreciation, amortisation)
2. Starting from Net income:
EBITDA = Net Income + Interest + Taxes + Depreciation + Amortisation
*Depreciation: spreading out the cost of physical things like machines or buildings as they wear out.
*Amortization: spreading out the cost of non-physical things like patents or software over time.
Here is a guide on how to calculate EBITDA.
EBITDA Margin: Measuring Efficiency
EBITDA Margin = EBITDA / Total Revenue
This shows how good a company is at turning sales into profit. The EBITDA margin is worked out by dividing EBITDA by revenue. It tells us what share of each dollar earned from sales is kept as profit after covering the basic costs of running the business. A higher margin is better because it means the company is keeping more money from its sales, showing it runs more efficiently. A lower margin means costs are taking up more of the sales, leaving less profit.
Limitations
While EBITDA is helpful, it isn’t perfect.
Doesn’t assess debt repayments or tax burdens: One of the biggest drawbacks of EBITDA is that it leaves out interest and taxes. That means a company might appear profitable on the surface, but in reality, a large portion of its earnings could be going toward paying off loans or covering its tax obligations. For investors or analysts, this makes EBITDA a limited tool when assessing whether a company can actually handle its financial commitments.
It overlooks long term costs: EBITDA also ignores depreciation and amortization, which are ways of accounting for the wear and tear of assets over time. If a company relies heavily on machinery, technology, or infrastructure, these costs matter a lot. By skipping over them, EBITDA can paint an overly optimistic picture, making it look like the business is more sustainable than it really is in the long run.
It’s not the same cash flow: While EBITDA is often used as a shortcut to estimate cash flow, it isn’t a true reflection of the money moving in and out of a business. It doesn’t capture the impact of working capital changes; things like late customer payments or inventory build-up. As a result, a company might report strong EBITDA numbers but still struggle with day-to-day cash management.
Here is a guide on the limitations of using EBTITDA.
How Inaam Helps
Inaam we combine financial indicators like EBITDA with impact data. We will provide and incorporate the definition and real life reflection of what that amount is for each company in the portfolio. That way, you don’t just see whether a company is making money, you also see how it makes money, and the broader social and environmental impact of its operations.
Final Thought
You don’t need to be an accountant. By knowing this one metric, you can cut through complexity and get a clearer view of a company’s true health - beyond the headlines.
