What is earnings before interest, taxes, depreciation and amortization (EBITDA)?

EBITDA starts with net income and adds back interest expense, income taxes, depreciation and amortization. Removing financing costs, taxes and non-cash charges isolates the earnings produced by a company's operations, which makes it easier to compare businesses with different capital structures. It is not a GAAP measure, so its exact calculation depends on who prepares it.

In commercial lending, EBITDA is the base for several key ratios, including funded debt to EBITDA and many versions of the debt service coverage ratio. Loan agreements define EBITDA precisely for covenant purposes, often permitting specific adjustments for non-recurring items. Analysts typically measure it on a trailing twelve month basis and compare it across several years to identify trends.

EBITDA overstates cash available for debt service because it ignores capital expenditures, changes in working capital and cash taxes. Capital-intensive businesses can show healthy EBITDA while consuming cash. Adjusted EBITDA presented by borrowers or sponsors may include aggressive add-backs, such as projected cost savings, that never materialize. Credit analysts should reconcile EBITDA to the income statement and scrutinize every add-back against the covenant definition.