Enter revenue, cost of goods sold, operating expenses and depreciation. You get EBITDA, EBITDA margin, operating profit and net profit, so you can see exactly what is being added back.
EBITDA starts from operating profit and adds back two non-cash charges. It is not a line that appears in standard accounts, it is a measure constructed from them, which is why the same business can report several different EBITDA figures depending on what someone chose to add back.
Depreciation. The cost of equipment spread across its useful life. A delivery van bought for $38,400 and expected to last five years shows up as $640 a month, even though all the cash left in one go on the day it was bought.
Amortisation. The same idea applied to intangible assets: capitalised software, acquired customer lists, licences.
Interest and tax. Excluded because they depend on how the business is financed and where it is incorporated, not on how well it trades.
The logic is that none of these four reflect the performance of the operation in the current month. Depreciation describes a purchase made in the past. Interest describes a financing choice. Tax describes a jurisdiction. Strip them out, the argument goes, and you are left with a clean view of what the trading generates. The argument is partly right, and the part that is wrong is where most of the misuse happens.
| Profit line | Amount | Margin | What it answers |
|---|---|---|---|
| Gross profit | $15,712 | 42.0% | Is the product worth selling |
| EBITDA | $3,502 | 9.4% | What trading generates before financing and asset costs |
| Operating profit | $2,862 | 7.7% | Whether the business covers its full cost of operating |
| Pre-tax profit | $2,682 | 7.2% | After the cost of debt |
| Net profit | $2,119 | 5.7% | What the owners actually keep |
EBITDA is the second line, not the first. It is always higher than operating profit whenever the business owns anything that depreciates, and it is always higher than net profit. That is exactly why it is the number people prefer to quote.
For an asset-light business the gap is small. For a business running vehicles, machinery or a warehouse, EBITDA can be double operating profit, and quoting it alone makes the business look twice as profitable as it is.
Adjusted EBITDA is where the measure is most often stretched, and advertising is one of the lines people try to stretch it with. The argument runs that acquisition spend is an investment in future customers, so it should be treated like capital expenditure and added back.
It should not be. Advertising is a recurring cash cost of generating the revenue on the same statement. If it stopped, the revenue would fall. Adding it back produces a figure that describes a business which receives the sales without paying for them, and no such business exists.
The same logic applies to stock-based compensation, recurring restructuring charges and anything else labelled one-off that appears every year. If an item is in the adjustments column two years running, it is an operating cost.
For decisions about ad spend itself, EBITDA is not the right number at all. Budgets are set against contribution margin, and whether the business can afford the total is a question for operating margin.
EBITDA is not cash. The van still has to be paid for, and replaced.
The central trap is treating EBITDA as cash. Depreciation is non-cash in the month it is charged, but the asset it describes had to be paid for and will have to be replaced. A business that reports strong EBITDA while its equipment wears out is consuming its future. Cash available is closer to EBITDA minus capital expenditure, and for asset-heavy businesses that difference is the whole story.
The second trap is comparing across industries. A software company and a haulage firm with identical EBITDA margins have completely different economics, because one reinvests almost nothing in physical assets and the other replaces trucks on a cycle. EBITDA hides exactly the cost that separates them.
The third is adjusted EBITDA with no reconciliation. Every adjustment is a claim that a cost does not count. Ask for the list, check whether the same adjustments recur, and treat anything recurring as a real expense.
Use EBITDA to compare similar businesses with different financing and tax positions, which is what it was built for. Do not use it to decide whether a business makes money.
Operating profit, also called EBIT, is calculated after depreciation and amortisation. EBITDA adds both back. For a business with few physical assets the two are close; for one running vehicles or machinery EBITDA can be far higher.
No. Depreciation is non-cash when charged, but the asset it describes had to be bought and will have to be replaced. Cash available is closer to EBITDA minus capital expenditure, and for asset-heavy businesses that gap decides everything.
No. It is a recurring cost of generating the revenue on the same statement, and if it stopped the revenue would fall. Adding it back describes a business that gets its sales for free.
It depends on the industry and how asset-heavy the business is, which is also why EBITDA margins are poor for comparing across industries. Compare against businesses with a similar asset base, and against your own trend.
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