Where does EBITDA come from?
EBITDA is a measuring system that assesses a company’s financial performance while excluding factors like taxes and accounting and financing decisions that often lie outside of the regular, recurring consideration and control of the business’s operations. This is evaluated by taking the company’s net earnings before interest and taxes (EBIT) and then adding the depreciation and amortization (DA) expenses.
Knowing a company’s EBITDA margin is a way of measuring a company’s operating profitability. To calculate an EBITDA margin, one would take the company’s EBITDA number (say, $30,000), and divide it by the company’s total revenue (for example, $75,000), equaling 40%. A higher percentage correlates to lower operating expenses and thus a higher bottom lines.
The term EBITDA was introduced in the 1970s by John C. Malone, the former president and CEO of Tele-Communications, nicknamed King of Cable. It became a popular measurement of a company’s cash flow in the 1980s, with the acronym EBITDA becoming common in the business domain as early as 1981. EBITDA was heavily used by leveraged buyout investors as a tool to quickly assess whether floundering companies could successfully pay back interest on its debt over a reasonably short length of time, such as a few years, by comparing the ratio between the company’s interest and its EBITDA. This measurement system has since expanded to be used by many different types of industries, companies, and firms.
Writing for Forbes, certified treasury professional Ted Gavin described the EBITDA form of measuring profitability as a “great big lie” and a “fairy tale,” since it can make companies look as if they’re in better shape than they really are, among other accounting-related concerns. Other critics point out that EBITDA ignores so many expenses that it paints a false picture of how profitable a company really is, since a company can make itself seem more successful by showing off its EBITDA number in order to avoid displaying the severity of its high debt levels.
“When LinkedIn reported its second quarter earnings results, it revealed Microsoft paid just 63 times the company's trailing-12-month EBITDA.”
Adam Levy, “If Microsoft Overpaid for LinkedIn, Then Twitter Is Way Overpriced,” The Motley Fool (September 9, 2016)
“Over the past four quarters, Nathan's Famous generated $96.1 million in revenue, adjusted EBITDA of $20.2 million and free cash flow of $14 million.”
Antoine Gara, “Hot Dog! Nathan's Famous To Pay A Third Of Market Cap In Special Dividend,” Forbes (March 11, 2015)
“And it's valuing Time Warner at about 13 times this year's estimated Ebitda, a higher multiple than any of the big entertainment-media stocks command.”
Tara Lachapelle, “AT&T-Time Warner: Rethink Possible,” Bloomberg (October 24, 2016)