Quick Answer
EBITDA stands for Earnings Before Interest, Tax, Depreciation, and Amortisation. It measures operating profitability by stripping out financing decisions (interest), tax jurisdiction effects (tax), and non-cash charges (depreciation and amortisation). Calculate it as operating profit plus depreciation and amortisation, or revenue minus operating expenses excluding D&A. It is widely used by investors and lenders as a proxy for cash generation, though it has important limitations.
Method 1 (bottom-up): Net profit + Interest + Tax + Depreciation + Amortisation
Method 2 (top-down): Revenue - Operating expenses (excluding depreciation and amortisation)
Both methods should produce the same result. The top-down approach is often easier when building budget models.
Comparability. EBITDA strips out items that vary based on capital structure (interest), tax domicile (tax), and accounting policy (depreciation methods). This makes it easier to compare companies across different situations.
Proxy for cash flow. Because it excludes non-cash charges, EBITDA approximates how much cash the business generates from operations before capital expenditure, debt service, and tax.
Valuation. Enterprise value / EBITDA (EV/EBITDA) is one of the most common valuation multiples. UK mid-market companies typically trade at 6-12x EBITDA depending on sector, growth rate, and quality of earnings.
Debt covenants. Lenders commonly use EBITDA-based covenants — for example, requiring net debt / EBITDA below 3x, or interest cover (EBITDA / interest) above 3x.
Adjusted EBITDA. Excludes one-off or non-recurring items: restructuring costs, share-based compensation, M&A expenses. Common in investor presentations and management reporting. Be cautious — excessive "adjustments" can mask poor underlying performance.
EBITDA margin. EBITDA / Revenue x 100. Shows operating efficiency. Typical margins vary by sector: SaaS 20-40%, professional services 15-25%, manufacturing 10-20%.
Run-rate EBITDA. Annualised EBITDA based on recent months, adjusted for known changes. Used in M&A to reflect the expected future earnings level.
Ignores capital expenditure. A business with heavy CapEx requirements (manufacturing, infrastructure) needs significant reinvestment just to maintain operations. EBITDA overstates available cash for these businesses.
Ignores working capital. Growing businesses often consume cash through increasing receivables and inventory, even while EBITDA is positive.
Ignores tax. Tax is a real cash cost. A company with £1m EBITDA and £300k tax liability has very different cash generation than one with £1m EBITDA in a tax-efficient structure.
Can be manipulated. Aggressive revenue recognition, capitalisation of costs, or excessive "adjustments" can inflate EBITDA without improving real cash generation.
Use EBITDA as one metric among several. Always complement it with operating cash flow (which captures working capital and CapEx) and free cash flow (which captures all real cash movements). When presenting EBITDA to the board, clearly define what is included and excluded, and be transparent about any adjustments.
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FAQ
No. EBITDA is a P&L metric that approximates cash generation but ignores working capital movements, capital expenditure, tax payments, and debt service. A company can have positive EBITDA and still be cash-negative. Always look at actual cash flow alongside EBITDA.
It varies significantly by sector. SaaS companies typically target 20-40% EBITDA margin at scale. Professional services firms aim for 15-25%. Manufacturing companies often achieve 10-20%. Compare against sector benchmarks rather than applying a universal target.
Budget both. Operating profit includes depreciation and amortisation and is the standard accounting measure. EBITDA is useful for cash-focused analysis and comparability. Your budget model should naturally produce both: operating profit is a line in the P&L, and EBITDA is operating profit plus D&A.
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