F2F Class Notes (Andrew)

EBITDA is a measure of profitability and is used to evaluate a company’s financial performance. It is used frequently by analysts and investors as an alternative to looking at net income/earnings because the metric focuses on the profitability of a company’s core operations. It dials in on the operations by stripping out the effects of non-operating items such as interest, taxes, depreciation, and amortization. Hence the acronym EBITDA. EBITDA stands for “Earnings Before Interest, Taxes, Depreciation, and Amortization.” When looking at the EBTIDA of a company, you are looking at the earnings before considering other items that are unrelated to management’s decision making and execution. Why Take Out Interest, Taxes, Depreciation, and Amortization? Simply put, EBITDA can give analysts and investors a clearer assessment of how a company is operating and if it is profitable. Expenses for interest, taxes, and D&A result from decisions and policies on financing, government, and accounting. When you remove that from the equation, you are left with a financial metric that reflects the profitability of a company through its core operations. It also levels the field for comparing different companies within the same industry. Interest, taxes, and D&A all have different levels of impact for every company. When you compare the EBITDA of several companies, you are comparing the profitability (from core activities) of one business versus another. Let’s break down why these line items are stripped out for this metric. Interest Expenses related to interest depend on the capital structure of the company. Companies are financed through debt and equity. If a company has more debt, they will have more interest. While interest is important, it is left out for EBITDA since paying interest does not reflect if a company’s business is performing well or not. It only reflects financing decisions. If a company has high interest expenses and a low net income as a result, it can skew the perception of that company’s worth. Taxes can vary from company to company depending on where it conducts its business. Taxes are paid at the federal, state, and local levels. Since taxes are external, ever-changing, and don’t fluctuate whether a company is performing well or not, they are excluded. Depreciation and Amortization D&A are non-cash expenses that result from the value of tangible and intangible assets decreasing in value over time. Companies need assets such as property, plant, and equipment to run their business and expand. However, expenses related to depreciation are realized on the income statement each accounting period. These expenses are taken out for EBITDA because they do not reflect the performance of the business. A company could have healthy profits when looking at EBITDA. But if they have high depreciation expenses, that could result in a low net income which can lead investors in thinking a company is performing poorly.

Vocabulary

Analysts, stripped, funding, matrix, skew, level the (playing) field

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