What EBITDA Means and Why Lenders and Investors Use It

Building EBITDA from the P&L

EBITDA is not a line you will find in statutory accounts — it is calculated by taking operating profit (EBIT) and adding back two non-cash charges: depreciation on tangible assets and amortisation on intangible assets such as goodwill or acquired intellectual property. The result approximates the cash the business generates from operations before it pays interest to lenders or tax to HMRC.

For example: if a company reports operating profit of £400,000 after charging £80,000 depreciation and £20,000 amortisation, its EBITDA is £500,000. If the business carried £1.5 million of net debt, a lender would describe this as 3x leverage — a figure they can compare against sector norms and their own credit policy.

Why lenders and investors prefer EBITDA

EBITDA allows comparison between businesses with different capital structures (some debt-heavy, some equity-funded), different depreciation policies, and different tax positions. By stripping all three out, it isolates the operating performance of the underlying business model — the question a lender or acquirer is really trying to answer.

It is also a reasonable starting point for estimating debt service capacity. A business generating £500,000 EBITDA can, in principle, support meaningful interest and loan repayment commitments, although the actual capacity depends on working capital, capex requirements and cash conversion — which EBITDA does not capture.

The limitations directors must understand

EBITDA is useful but imperfect. Its most significant limitation is that it ignores capital expenditure. A business that must spend £200,000 per year replacing worn-out machinery to sustain its revenue has very different cash economics from one that requires no capex — yet both might report identical EBITDA. Free cash flow (EBITDA minus capex minus working capital changes) addresses this but is harder to compute from published accounts.

EBITDA can also be manipulated by changes in capitalisation policy — choosing to capitalise development costs rather than expensing them, for instance, reduces the depreciation and amortisation add-back. Directors should be sceptical of EBITDA improvements that do not correspond to improved operating cash flow.

EBITDA in practice: what directors are asked to provide

When applying for a term loan, commercial mortgage or acquisition finance, your lender will almost certainly ask for EBITDA — usually for the last two or three completed financial years plus the current year to date. They may also request adjusted EBITDA, which adds back one-off or non-recurring costs (a large legal settlement, a restructuring charge) that are unlikely to repeat.

• Know your trailing twelve-month EBITDA before approaching any lender
• Be prepared to justify any add-back adjustments with documentation
• Understand how seasonality affects your year-to-date EBITDA annualisation
• Ask your accountant to prepare a clean EBITDA bridge if the statutory accounts are complex