EBITDA

What EBITDA tries to show

Start with net profit and add back four things: interest, income taxes, depreciation and amortization. What remains is meant to be the earning power of the operating engine itself.

The logic behind each add-back: interest depends on how much debt the owner chose to carry, not on how well the shop runs. Taxes depend on structure and jurisdiction. Depreciation and amortization are accounting charges that spread the cost of past equipment purchases over years, so they reflect how old your assets are and which accounting choices you made, not this year's operations.

The measure grew up in the world of buyouts and lending, where analysts needed to compare businesses carrying very different debt loads. Two identical restaurants can show very different net profit margins if one borrowed heavily to open and the other was funded with cash. Their EBITDA, in principle, should look the same.

Where Canadian business owners meet EBITDA

Selling or valuing a business. Sale prices for private businesses are commonly quoted as a multiple of EBITDA, and generally speaking, small businesses change hands at low single-digit multiples, with the exact figure driven by size, growth, customer concentration and how dependent the business is on the owner. If you ever plan to sell, EBITDA is the number a buyer's first offer will be built on.

Bank covenants. Business loan agreements often require you to maintain ratios such as debt to EBITDA or a minimum coverage of loan payments by EBITDA. Breaching a covenant can put a loan in default even when payments are current, so owners with commercial debt should know their EBITDA and track it.

Franchise disclosure documents. Franchisors often present the earnings of existing locations in EBITDA-like terms. Read carefully: a location's EBITDA is not what you would take home after loan payments, equipment replacement and tax.

The famous critique

EBITDA has been mocked by some of the world's most famous investors, and the critique is worth taking seriously. Depreciation is a real cost, just a delayed one. The delivery van wears out. The ovens, the computers and the roof all wear out. Treating depreciation as if it were not an expense assumes, as the joke goes, that the tooth fairy pays for capital spending. Someone has to pay for the equipment, and that someone is you.

EBITDA is not cash flow. It ignores the cash you must spend on new and replacement equipment, and it ignores working capital: the money that gets tied up in inventory and receivables as a business grows. A company can report healthy EBITDA while its bank account drains. If you want to know what the business actually generates in cash, look at cash flow, not EBITDA.

The measure is most misleading exactly where depreciation is largest: businesses with lots of equipment, vehicles or leasehold improvements. For an asset-light consulting firm, EBITDA and true operating profit sit close together. For a trucking company, the gap can be enormous.

Adjusted EBITDA and its abuses

Sellers often present adjusted EBITDA or normalized EBITDA: the reported figure plus add-backs for the owner's above-market salary, personal expenses run through the company, and one-time costs. Some adjustments are legitimate and expected; the honest line is that every adjustment moves the number in the seller's favour, and "one-time" costs have a way of recurring, so each add-back deserves scrutiny.

When EBITDA is genuinely useful

Used for what it was built for, EBITDA earns its keep. It is a fair way to compare operating engines across businesses with different financing, tax situations and asset ages, and to track your own operating performance over time without noise from refinancing or asset purchases. Lenders use it as a rough proxy for the cash available to service debt, which is why it anchors their capacity math. The mistake is not using EBITDA; it is treating it as profit or as cash. It is neither. It is a comparison tool.