Can you explain four advantages of using EBITDA as a measure of financial performance?

Advantages of using EBTIDA

1. It is a good proxy for cash flow from operations and as such is a measure of underlying performance. It can be seen as the proportion of operating profits converted to cash.

2.EBlTDA is easy to calculate and understand.

3.EBITDA can be used to assess the performance of a manager who has no control over acquisition and financial policy as it excludes costs associated with assets (depreciation) and debt (interest)

EBITDA - Earnings before interest, taxes, depreciation and amortization is an indicator of a company's financial performance which is calculated in the following manner:

EBITDA = Revenue - Expenses (excluding tax, interest, depreciation and amortization).

EBITDA is essentially net income with interest, taxes, depreciation, and amortization added back to it, and can be used to analyze and compare profitability between companies and industries because it eliminates the effects of financing and accounting decisions.

This is a non-GAAP measure that allows a greater amount of discretion as to what is (and is not) included in the calculation. This also means that companies often change the items included in their EBITDA calculation from one reporting period to the next.

EBITDA first came into common use with leveraged buyouts in the 1980s, when it was used to indicate the ability of a company to service debt. As time passed, it became popular in industries with expensive assets that had to be written down over long periods of time. EBITDA is now commonly quoted by many companies, especially in the tech sector - even when it isn't warranted.

A common misconception is that EBITDA represents cash earnings. EBITDA is a good metric to evaluate profitability, but not cash flow. EBITDA also leaves out the cash required to fund working capital and the replacement of old equipment, which can be significant. Consequently, EBITDA is often used as an accounting gimmick to dress up a company's earnings. When using this metric, it's key that investors also focus on other performance measures to make sure the company is not trying to hide something with EBITDA.  To learn more about other key investing concepts, sign up for our Investing Basics newsletter.