EBITDA

EBITDA can be assembled in either direction, and a candidate should be fluent in both. Working up from the bottom of the income statement, start with net income, add back tax expense and net interest expense to recover pre-tax operating profit, then add back depreciation and amortisation. Working down from the top, start with revenue and subtract cost of sales and operating expenses excluding any D&A embedded in them.

The two routes rarely agree on the first attempt, and the discrepancy is instructive. Depreciation is frequently buried inside cost of goods sold rather than shown as a separate line, so the top-down build understates D&A unless the analyst pulls the full charge from the cash flow statement or the property, plant and equipment note. Non-operating items such as investment income, restructuring gains, or equity-method earnings also drift into the bottom-up path and must be handled deliberately rather than absorbed silently.

EBITDA earns its place in practice because it sits above the capital structure. Interest expense reflects how a firm chose to finance itself; depreciation reflects historical purchase prices and depreciation policy. Removing both produces a figure that is broadly comparable across firms with different leverage and different asset vintages, which is precisely what a lender or an acquirer needs when the financing and the asset base are about to change.

This is why leveraged loan and high-yield documentation is written around EBITDA: net debt to EBITDA sets maximum leverage, and EBITDA to interest expense sets coverage. In valuation, enterprise value to EBITDA pairs a total-capital numerator with a pre-interest denominator, so the multiple is internally consistent in a way that price to earnings is not when leverage differs. Cross-border comparisons benefit too, since tax regimes and amortisation rules for intangibles vary sharply by jurisdiction.

EBITDA is silent on three things that determine solvency. It ignores capital intensity: a business that must continually replace its asset base has real economic depreciation, and adding the charge back does not make the reinvestment optional. It ignores working capital, so a firm growing receivables and inventory faster than sales can report rising EBITDA while consuming cash. And it ignores the cost of debt service and taxes, both of which are contractual or statutory rather than discretionary.

Accounting choices also move the number in ways unrelated to performance. Capitalising development costs or contract acquisition costs shifts spending out of operating expense and into amortisation, lifting EBITDA. Under IFRS 16 nearly all leases produce depreciation and interest rather than rent expense, raising reported EBITDA relative to firms that historically expensed operating leases. Stock-based compensation, a genuine cost to shareholders, survives in EBITDA but is often stripped out in adjusted versions.

At Level I the practical skill is reconstruction and critique rather than memorisation. Given a set of financial statements, you should be able to derive EBITDA from either end of the income statement, locate the true D&A charge in the cash flow statement or asset notes, and state which items you excluded and why. You should also be able to convert between EBITDA and cash flow from operations conceptually: the gap is taxes paid, cash interest, and the change in working capital.

Equally important is judgement about comparability. When a vignette contrasts two firms, ask whether differing capital intensity, lease accounting, or capitalisation policy is doing the work behind an apparently cheap multiple. When a company presents its own adjusted figure, the analytical response is to reverse the adjustments back to a reported basis and test whether the excluded costs are genuinely non-recurring.