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Earnings before interest, taxes, depreciation and amortization (EBITDA) is a measure commonly used to evaluate a company's profitability and the operational performance of its core operations as compared to its competitors, as it eliminates the effects of varying accounting policies, as further discussed below. EBITDA is frequently used in company valuation; the determination of a purchase price and loan covenant definitions are often quoted as multiples of EBITDA.
All of the components used to calculate EBITDA can be found on a company's income statement. However, unlike the financial terms on a company's income statement and other financial statements, EBITDA is not a defined term under Generally Accepted Accounting Principles (GAAP), guidelines that regulate the preparation of financial statements. This means that the methodology of calculating EBITDA can vary from one company to another - or even within the same company from period to period. On a high level, some very basic adjustments to EBITDA can include onetime occurrences for items such as restructuring charges, which are common practice in distressed situations, to costs associated with non-recurring litigation expense.
EBITDA is also commonly used by many finance professionals as an estimate of a company's ability to generate cash. While a negative EBITDA generally indicates that a business has a profitability issue and insufficient cash flow from its core operations, a positive EBITDA does not necessarily mean that a business will generate cash. EBITDA can be a useful metric for some companies, given that it strips away non-cash reductions to earnings. For example, "fixed assets" (also known as tangible assets or property, plant and equipment) is an accounting term used for assets and property that cannot easily be converted into cash. This can be compared with current assets such as cash or bank accounts, which are described as "liquid assets." The cost of purchasing a fixed asset is not recorded as a reduction to earnings (/.<?., placed on the income statement) at the time of purchase. Rather, the initial cost is recorded on the balance sheet and later allocated, as a depreciation expense, among periods in which the asset is expected to be used. To further illustrate, if a company purchases a piece of equipment for $100,000 and it is expected to last 10 years, a...