EBITDA

In accounting, EBITDA stands for "Earnings before Interest, Taxes, Depreciation, and Amortization". When companies publish their financial statements, the most important metric for investors is the company's income, which is calculated as the company's revenue minus all its expenses. Some companies also publish their EBITDA, which, these companies usually claim, provides a more true picture of the company's profitability than the "income" number.

Specifically, a company's "income" number is always distorted by decisions that the company made in previous years. Depreciation of capital expenditures is a particularly strong factor. For example, if a company spends $99 million in new desktop computers for all its employees, the company will often decide to depreciate the purchase over three years. This way, in the first year, when the company calculates its "income" number, it pretends that it has only spent $33 million that year on desktop computers. The company's income number paints a more rosy and optimistic picture than actually occurred that year. In each of the second and third years, the company also pretends that it has spent $33 million per year on desktop computers. Hence, the company's financial picture was probably healthier than indicated by the income number, since the $33 million had actually already been paid out.

The EBITDA number, it is claimed, does not suffer from this distortion in the second and third years, so investors can get a better idea of how profitable the company really is. Some purchases are depreciated or amortized over 20 years or more, with a negative impact on the business's "income" number long after the actual financial effects of the purchases have ceased.

Critics include Warren Buffett, who famously asked, "Does management think the tooth fairy pays for capital expenditures?" Hypothetically, a company could spend a trillion dollars on capital expenditures, and this would never show up in the next million years of the company's EBITDA reports. The "income" number is therefore a more true picture, say critics of EBITDA reporting, and if an investor wishes to examine short-term financial performance, he should examine the "operating cash flow" numbers.

Most dot-com companies attempted to promote their stock by means of emphasizing either EBITDA or pro forma earnings in their financial reports, and explaining away the (often poor) "income" number. In the United States, the Securities and Exchange Commission has cautioned companies that they will be charged with fraud if they use these alternative numbers in order to mislead investors.