IF YOUR FIRST THOUGHT, when reading the title of this article was, what the hell is EBITDA?, then you’re not alone—this article was written for millions of people just like you who have never heard of it. EBITDA is fancy tax lingo for earnings before interest, taxes, depreciation, and amortization. Since I just heard many of you go, ohhhhh…, I think that the concept isn’t completely unfamiliar. Before I delve deeper, I’ll explain what depreciation and amortization mean. Depreciation is a decrease in an asset’s value, which is always tangible, caused by unfavorable market conditions. It can also be defined as the method of allocating the cost over its useful life. Amortization is the paying off of debts in regular installments over a period of time which is usually done for the intangible assets.
The importance of EBITDA comes in as it is the measure of the value of any given business. One does not measure the value of the business by the cash flow as this will not fully demonstrate the net worth of the company. This is why many companies have adopted EBITDA as the only way to determine the true net worth of a company. It is calculated by taking the net income of the company and adding the interest. After which, the taxes, depreciation and amortization are put together to find out what the company is essentially worth. This calculation is a better determinant than the cash flow that one may be having.
A good factor to consider is that the EBITDA is a shortcut that is used to determine the cash flow that is available to pay of the debts accrued on the items that gain worth in the future, such as machines and other equipment found in the office or company.
This calculation has saved many companies from going under and becoming obsolete. It is a great measure that eliminates the extraneous factors in any given company. Many people get the wrong image of EBITDA and that is why there are financial experts who can best let you know the differences between all the calculations and the terms used to address the calculations.
