EBITDA

EBITDA is the initialism for earnings before interest, taxes, depreciation, and amortization. It is a non-GAAP metric that is measured exactly as stated. All interest, tax, depreciation and amortization entries in the income statement are reversed out from the bottom-line net income. It purports to measure cash earnings without accrual accounting, canceling tax-jurisdiction effects, and canceling the effects of different capital structures.

EBITDA differs from the operating cash flow in a cash flow statement primarily by excluding payments for taxes or interest as well as changes in working capital. EBITDA also differs from free cash flow because it excludes cash requirements for replacing capital assets (capex).

EBITDA Margin refers to EBITDA divided by total revenue. EBITDA margin measures the extent to which cash operating expenses use up revenue. 

Public investors' use of EBITDA arose from their perception that accountants' measure of profits, using accrual accounting was manipulated, that a measure of cash earnings would be more reliable. It is true that PE can use this metric. And it is true the professional analysts using detailed discounted cash flow models should replace non-cash expenses with projected time-weighted payments. But none of that applies to retail investors' reality.

EBITDA does NOT measure cash earnings because it omits all the tax expenses even though a good portion are cash payments. It also fails to correct for other non-cash expenses, e.g. warranty expense, bad debt allowance, inventory write-down, stock options granted.

It does not include the cash flows from changes in working capital. Suppose a business sells all its opening inventory in a year and replaces the same number of units but at a higher price because of inflation. The profits of a company using FIFO inventory valuation will not include that extra cash cost. Suppose the business is expanding and need to stock a larger number of units. That additional cash cost is not in anyone's EBITDA measure.

When using this metric to replace accountant's earnings it presumes to measure an economic profit. But any economic profit must include the cost of capital and the degradation of long-life assets. This metric simply ignores both. Warren Buffett famously asked, "Does management think the tooth fairy pays for capital expenditures?" Depreciation may not be exact but it is the most practical method available. It succeeds in equating the positions of companies using three different ways to finance long-life assets. 

It can be interpreted as: 

the allocation of the original cost, at a later date, when the asset was used to generate revenue. The time-value-of-money (same argument used above) means that depreciation may understate the cost.

the amount of cash required to be retained in order to finance the eventual replacement asset. Since inflation is the basis for time-value-of-money, the amounts set aside today must be invested and grow in value in order to pay the inflated price in the future.

the decrease in value of the balance sheet asset since the last reporting period. Assets wear out with use, and will eventually have to be replaced.