July 23rd, 2009
12:22 PM GMT
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(CNN) – The Quest Means Business team has been tasked to try and explain business jargon to its viewers.

We are often guilty of throwing terms around when talking about company results that are difficult to explain in a sentence or two.

EBITDA (Earnings Before Interest, Taxes, Depreciation and Amortization) is one of those for me.

So I was pleased to delve into it, not only to try and explain it, but also to really get my head around it. Why did companies publish EBITDA figures during the dotcom bubble era? Why do few companies use it now? Why is it not acceptable under so-called U.S. Generally Accepted Accounting Principles (GAAP)?

Ok, I will try and explain it again. Basically (and really basically) it’s a way to express a company’s earnings (the same as net income or profits or the “bottom line”) in a given period. But it is a number that is expressed before the company strips out recurring charges or costs like taxes, interest paid on debt, the loss of value of assets etc. (If I write anymore, I will confuse myself).

Companies use EBITDA (and ITDA and other complication formulae) especially when the number is positive while all others may be negative: “Company X lost six billion dollars last quarter, but EBITDA grew 15 percent!”

To be fair it is a way to try and show a consistent number if a new company is growing fast and spending huge amounts of money so it has no hopes of turning a profit. That is why it became a popular number during the late 1990s.

Today, private equity likes to look at EBITDA figures during a potential takeover because it helps to clarify a company’s underlying ability to earn money.

Is it any clearer to you now?

If not, the video below shows me trying to explain it to a classroom full of children. They were enthusiastic to learn and were shouting “EBITDA” when we packed up to leave their London school.

soundoff (5 Responses)
  1. Matthew Roberts

    This is a good explanation, but leaves the reader with the question of what are the emerging guidelines or trends for reporting income given a new set of economic circumstances. When shareholders are interested in their companies sustainability and long-term ability to generate value for their stakeholders, what is the emerging acronym to look for? What should we look for when a companies very survival is at stake?

    July 23, 2009 at 7:19 pm |
  2. Usman Rahman

    Well, indeed the figure represents the underlying ability to earn money but as it is fraught with possibilities of manipulation due to management choices of accounting policies, a much more useful term is Cashflow from Operations (CFO) that reflects much better the "quality of profits" being earned as the impact of subjectivity and accounting policies is generally taken out of the equation.

    Indexing the CFO to EBITDA over the years can determine a pattern as to if the accounting policies are being too aggressive or convervative.

    Admittedly, the above would be quite difficult to decode for the young audience that was the subject of the article in the first instance....

    July 26, 2009 at 3:44 pm |
  3. Jay

    EBITDA is a meaningless line item used primarily to justify why a company is not profitable for the following reasons:

    1. Too much debt (interest expense).

    2. Substantial capital expenditures for equipment and other intellectual property (depreciation and amortization expense).

    The cash flow statement is the most informative finacial statement in my opinion. I place very little stock in the income statement of any publicly traded company because it is prepared using accrual accounting.

    Cash is and will always be king.John Folson, CPA, P.A.

    August 1, 2009 at 5:06 pm |
  4. Randall Shores

    Why is the media not talking about the April, 2009 U. S. Geological Survey report that says that the Hakken Oil Field/Formation in North Dakota has over 410 Billion Barrels of recoverable oil. More than Saudi Arabia but no media coverage. This report estimates the cost of recovery is $16 per barrel to produce. But there is no rush to develop.

    The American people are idiots if they think the oil industry is producing all the oil they can. Federal oil leases let oil companies extend, extend, and extend federal oil leases without drilling one well. Over 60 millions Federal acres are currently under lease with no drilling. The American people are being ripped off every time a Federal oil lease is signed and everytime they fill up their gas tanks.

    By the way, IRS Code Section 613 means that the Federal government is providing Tax Subsidies to the Oil Industry, Coal Industry, Iron Ore Industry, Gas Industry, etc. Another Code section subsidizes Acher Daniel Midland's production of HFCS (High Fuctose Corn Syrup) the sweetener that is making American's FAT and an important cause of diabetes.

    August 5, 2009 at 4:44 pm |

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