EBITDA

EBITDA refers to the earnings before interest, taxes, depreciation and amortisation. This is a type of measurement process which allows an investor to have some idea about how much money a company is generating before the deduction of taxes, deprecation and amortisation. It is very much important for any investor to know how much money a particular business is making before deciding whether to invest money in that business and EBITDA is considered as one of those methods that can be used by the investor to find that. EBITDA is calculated through the following formula:

EBITDA = Revenue - Expenses (excluding taxes, interest, depreciation and amortisation)

Although the concept of EBITDA is well known in the corporate world and is considered as a common method of analysing the financial performance of a company, critics claim that it can overstate the profitability of company since under this system of calculation, vital business costs are not taken under consideration. Say for example, EBITDA does not include the cash payments for covering the interest on debt, taxes, depreciation of equipments as well as amortisation in the calculation. According to some, EBITDA can artificially enhance the financial outlook of a company which may deceive the investors.

However, there are some other methods available for the investors to come up with a more accurate calculation of the financial performance of a company. One of them can be the free cash flow system (in short FCF). Under this method, capital expenditures are deducted from business cash flow figure. FCF considers capital expenditures, inventory and receivables for the calculation which is not taken into account in case of EBITDA. This is why, FCF is considered as a more reliable method for identifying the financial condition of a company than EBITDA.