What is EBITDA, why is it popular, and what are its limitations?
What the interviewer wants to hear
- Earnings before interest, tax, depreciation and amortisation
- Useful to compare operating profit across capital structures and tax regimes
- Proxy for operating cash flow and used in multiples and covenants
- Ignores capex, working capital, interest and tax which are real cash needs
- Adjusted EBITDA can be abused
Model answer
EBITDA is earnings before interest, tax, depreciation and amortisation. It is popular because it strips out financing choices, tax differences and non-cash charges, so you can compare the operating profit of companies with different debt levels or asset ages. It is also used in EV/EBITDA multiples and in bank covenants like net debt to EBITDA. But it has real limitations. It ignores capex, which for a telecom or cement company is a large and recurring cash need. It ignores working capital, so a company with growing receivables can show strong EBITDA and weak cash. It also ignores interest and tax, which must be paid. And many companies report an adjusted EBITDA that removes costs they call one-off but which recur. So I use EBITDA as a starting point, then always look at free cash flow.
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