Insights · Financial Analysis
What EBITDA means in plain language
EBITDA is a performance indicator designed to show a company’s earnings before interest, income taxes, depreciation and amortisation. The acronym stands for Earnings Before Interest, Taxes, Depreciation and Amortization. Its definition should always be specified when making comparisons, because the adjustments adopted by different companies may vary.
Imagine a small company selling hygiene products. Its owner wants to understand whether the core business generates enough earnings to support its operating structure. EBITDA provides one useful view, setting aside certain accounting and financing effects. It does not, however, measure cash actually received from customers or payments made to suppliers.
The principle is straightforward: an indicator can be positive while a company struggles to pay wages or invoices. Financial analysis must therefore bring together the income statement, balance sheet and cash-flow information.
How to calculate EBITDA: a step-by-step example
Consider a fictional SME with annual figures in euros, excluding VAT: revenue of €300,000, cost of goods sold of €120,000, staff costs of €90,000 and other recurring operating expenses of €45,000. Assume there are no other material operating items. Simplified EBITDA = €300,000 − €120,000 − €90,000 − €45,000 = €45,000.
If depreciation and amortisation amount to €15,000, operating profit (EBIT) is €30,000. With interest expense of €6,000 and income tax of €5,000, illustrative net profit is €19,000. The three figures answer different questions: EBITDA of €45,000, EBIT of €30,000 and net profit of €19,000.
The EBITDA margin is €45,000 ÷ €300,000 = 15%. It means that EBITDA equals 15% of revenue in this example; it does not mean the company collected fifteen cents in cash for every euro invoiced.
Why EBITDA is different from available cash
The first reason is the collection period. A sale may be recognised today even though the customer will not pay for another 60 days. Accounting earnings reflect the sale; the bank account does not yet reflect the receipt. If sales rise quickly, trade receivables can increase faster than cash collections.
The second reason is inventory. Buying goods for the coming months requires cash. Some of those purchases may remain in stock instead of being recognised immediately as an expense. A business can have full warehouses and still lack liquidity.
The third reason is investment. Buying a machine for €25,000 requires a cash payment, but EBITDA does not deduct the purchase as a period operating expense. Depreciation of that machine is also excluded from EBITDA. As a result, an operation with positive EBITDA may still require substantial investment to continue operating.
The fourth reason is debt and other payments. Repayment of loan principal consumes cash without reducing EBITDA, while loan interest is excluded from EBITDA as a financing cost. Income taxes actually paid and distributions to shareholders also affect cash balances without being explained by EBITDA.
Example: €45,000 EBITDA but only €5,000 in operating cash
Return to the fictional company. To illustrate a simplified reconciliation, assume EBITDA of €45,000. During the year, trade receivables increase by €30,000, inventory by €15,000 and operating trade payables by €5,000. Ignoring other movements, an approximation of operating cash before interest and tax is: €45,000 − €30,000 − €15,000 + €5,000 = €5,000.
The company therefore reports EBITDA of €45,000 but approximately €5,000 of operating cash under this simplified reconciliation. Interest, tax and capital investment payments may still be due. This example does not replace a complete statement of cash flows; it shows why the figures can diverge so substantially.
This distinction follows the logic of IAS 7, which presents cash flows from operating, investing and financing activities, including adjustments for non-cash items and working-capital movements.
What EBITDA can and cannot tell you
EBITDA can help track operating profitability, compare periods and identify changes in the cost structure. If sales rise but the EBITDA margin falls, managers should investigate discounts, production costs, productivity and overheads.
However, comparing businesses solely by EBITDA is risky. A manufacturer requiring expensive machines every year and a service provider operating with few fixed assets may report similar EBITDA margins while having very different investment needs. EBITDA also does not show whether customers pay on time.
For SMEs, the analysis should include at least EBITDA, net profit, operating cash flow, trade receivables, inventory, scheduled payments and financial debt. None of these figures, viewed alone, describes the entire financial position.
A monthly review routine for business owners
A practical monthly routine is to answer five questions: how much did we sell, what operating margin did we earn, how much cash did customers pay, what payments did we make and how much cash is expected to be available over the next eight to twelve weeks?
Also review the average collection period and overdue receivables. If turnover rises while available cash falls, do not automatically conclude that performance has improved or deteriorated. Investigate collection schedules, purchasing, investment and financing commitments.
For example, a business may increase operating earnings by selling more on credit while its average collection period moves from 30 to 90 days. Management must decide whether the extra credit granted to customers was intentional and whether it can be financed. A weekly cash forecast identifies weeks when payments exceed receipts. The response may be to negotiate terms, reconsider investment or improve collections, not necessarily to seek more sales. Read EBITDA alongside other indicators, using consistent definitions and comparable periods.
EBITDA is useful when it informs a decision. It should never be used as a substitute for cash in the bank or as sufficient proof of financial health. Effective management considers both the earnings generated by the business and its ability to meet payments.