EBITDA stands for earnings before interest, taxes, depreciation and amortization. It is a non-GAAP measure of operating profitability that strips out the effects of capital structure (interest), tax jurisdiction (taxes) and historic capital-allocation choices (depreciation and amortization), giving a cleaner view of how much cash the underlying business generates from operations. EBITDA is the single most widely used profitability number in private-company M&A, and the denominator of the standard EV/EBITDA multiple.
How it is calculated
The two most common formulations:
Bottom-up: EBITDA = Net income + Interest expense + Tax expense + Depreciation + Amortization
Top-down: EBITDA = Revenue − Cost of goods sold − Operating expenses (excluding D&A)
Both produce the same number from a clean income statement.
Adjusted EBITDA
In M&A, the headline number that gets multiplied is rarely raw GAAP EBITDA. It is Adjusted EBITDA, which layers on normalization adjustments to remove one-time, non-operating and owner-specific items — for example: one-time legal settlements, COVID-era PPP forgiveness, above-market owner compensation, related-party rent and discontinued product lines. The resulting "run-rate" or "pro-forma" EBITDA is meant to reflect what the business will earn in a normalized year under new ownership. The independent test of these adjustments is the quality-of-earnings (QofE) report.
Why M&A practitioners use it
- Comparability across capital structures. A levered and an unlevered business can be compared on the same line.
- Comparability across tax regimes. US, UK and EU targets land on the same basis.
- A proxy for unlevered cash flow — though a rough one, since it ignores working-capital movement and capex.
- The basis of leveraged finance. Lender covenants are written as multiples of EBITDA (Debt/EBITDA, EBITDA/Interest), so lenders care about it as much as buyers do.
Limitations
EBITDA is famously the metric Charlie Munger called "bullshit earnings" because it ignores real costs: capital expenditure, working-capital reinvestment and stock-based compensation. For asset-heavy businesses (manufacturing, telecoms, infrastructure) EBITDA can substantially overstate cash generation. Modern practice is therefore to triangulate EBITDA with EBITDA − capex, free cash flow and the DCF.
See also
- EBITDA multiple — The ratio of enterprise value to EBITDA, the most common shorthand for what a business is worth in M&A. Industry, scale, growth and quality of earnings all move it.
- Seller's discretionary earnings — A small-business profitability measure equal to EBITDA plus owner compensation and discretionary expenses. Standard in lower-middle-market and main-street M&A.
- Normalization adjustments — Adjustments to reported earnings to remove one-time, non-operating or owner-specific items, producing a run-rate EBITDA that better reflects the ongoing business.
- Quality of earnings — An independent accounting analysis that tests how sustainable, predictable and accurately measured a target's reported earnings are. The QofE is a near-universal pre-LOI deliverable in serious deals.
- Discounted cash flow — An intrinsic valuation that discounts a company’s projected cash flows to present value.
- Business valuation — The set of methods used to estimate the economic value of a company or its equity, almost always triangulated across several approaches into a defensible range.