What is the EBITDA
The Earnings Before Interest Taxes Depreciation and Amortization (or EBITDA) is a measure of the operating profitability of a company.
The EBITDA has 2 main advantages: it is very easy to compute and it is a good proxy of the company's operating cash flow.
Impact of the EBITDA for the financial health of a company
The EBITDA is one of the key items to look for in a P&L as it is a good indicator of the operating health of a business.
A positive EBITDA means that the company is profitable at an operating level: it sells its products higher than they cost to make. At the opposite, a negative EBITDA means that the company is facing some operational difficulties or that it is poorly managed.
The EBITDA is a good proxy for cash generation capacity of the company. Contrarily to EBIT the EBTIDA doesn't incorporate the Depreciations and Amortizations (D&A) which are pure accounting charges (i.e. without any cash impact). The EBITDA is just a proxy of the operating cash flow because it doesn't take into considerations the impact of the changes in working capital.
The EBITDA is not impacted by the financial structure of the company (level of debt vs. equity) as neither the interest expense nor the corporation tax enter in the EBITDA calculation. This makes the EBITDA of a company directly comparable to other companies operating in the same sector.
The EBITDA is easy to compute from the P&L of the company and therefore enables financial analysts to quickly assess the financial health of the company using the following ratios:
EBITDA / Revenues:
This ratio measures the operating profitability of the business.
Operating cash flow / EBITDA:
This ratio, also called cash conversion ratio, assesses the efficiency of the company to turn the EBITDA into cash.
A low ratio indicates a potential working capital issue (clients paying late, high level of inventory, etc.).
EBITDA / financial expense:
Also called interest coverage ratio, this ratio gives an indication of both the liquidity of the company (i.e. its ability to fulfil its short term financial commitments) and of the weight of the debt of the company.
Banks use this ratio to check that the weight of the debt in the capital structure is at an adequate level and does not prevent the company from investing.
Net debt / EBITDA:
This ratio is used as a proxy to assess the company's solvency (i.e. its ability to face its financial commitments in the long run).
This ratio gives an indication of the minimum amount of years needed for the company to repay its debt entirely.