EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization) is a financial metric showing a company's profit before interest, taxes, depreciation, and the wear of fixed assets are deducted. In Russia at the start of the 1990s, this term was only just beginning to enter business vocabulary, mostly among businesspeople with contacts among Western partners.
The EBITDA metric was first put into practice in the 1970s by the American billionaire investor John Malone, who used it to assess telecommunications companies' ability to generate cash flow. Unlike traditional metrics such as earnings per share, EBITDA made it possible to more accurately gauge the financial capacity of fast-growing companies with heavy capital expenditure.
EBITDA became widely used in the 1980s, during the boom in mergers and acquisitions. In Russia and the former USSR in the early 1990s, the metric was known only to a very narrow circle of specialists — mainly those with a Western-style economics education or experience working with foreign companies.
In Russia in 1993, amid rapid economic transformation, the use of Western financial terms often had the character of fashionable jargon among the new class of entrepreneurs, who did not always fully understand their meaning.
Meaning and application of the metric
EBITDA makes it possible to assess a company's core operating performance without accounting for:
- Financing structure (interest payments)
- Tax regime (tax payments)
- Depreciation policy (wear and amortization)
In this way, EBITDA allows comparison of companies with different capital structures, tax conditions, and accounting policies, which is especially important when valuing a business and making investment decisions.
In 1990s Russia, amid high inflation, unstable tax legislation, and various tax-minimization schemes, the EBITDA metric could be especially useful for assessing a business's real potential. Its application, however, was limited by the lack of transparent financial reporting and the general instability of the economic system.
Calculation formula
EBITDA can be calculated in two ways:
- EBITDA = Net Profit + Interest + Taxes + Depreciation
- EBITDA = Revenue - Operating Expenses (excluding depreciation)
In practice, a modified metric — Adjusted EBITDA — is often used, which excludes one-off expenses and income atypical of the company's core operations.
Criticism and limitations
Despite its popularity, EBITDA has a number of significant limitations:
- It does not account for the capital expenditure needed to maintain assets
- It ignores changes in working capital
- It is not a standard metric under Generally Accepted Accounting Principles (GAAP)
The renowned investor Warren Buffett criticized excessive attention to EBITDA, sarcastically asking: "Does management think the tooth fairy pays for capital expenditures?"
In the context of early-1990s Russia, many businessmen often used Western financial terms, including EBITDA, to make their businesses look more solid and modern, but without a deep understanding of their substance or correct application in financial analysis.
In particular, the slang expression "have a look at the ibida" (a mangled pronunciation of the EBITDA acronym) reflects the new Russian entrepreneurs' attempt to adopt Western methods of financial analysis, often with only a superficial grasp of their substance.