EBITDA means earnings before interest, taxes, depreciation and amortization. It is an indicator of how well a stock does in its day-to-day operations, compared to other companies. It shows the company's profitability before interest, taxes and accounting decisions that count as expenses, such as depreciation.

Indeed, EBITDA stands as a measure and therein can be seen the core features of the business and about the ability to generate proper cash flow. Here's a closer look at what EBITDA does and doesn't tell you:

What EBITDA Tells You

- Profitability from core operations: Through reduction of interest, taxes and the adjustments due to accounting, EBITDA only focuses on operations and production, in order to represent the income derived from these activities. The visibility here is much improved, as such, it provides a clear perspective of what is going on within daily operations.

- Cash flow capacity: As EBITDA refers to cash operating profits a business can generate, it is a measure of the amount of cash a company can raise to satisfy its debt demands, make future investments or give away funds to shareholders. Increased earnings before interest, taxes, depreciation, and amortizations is usually a sign of higher cash flow.

- Operating leverage and efficiency: A firm's EBITDA is a metric used to calculate the scale of its operating margin when compared with its revenue. A higher proportion of such cost is an indication of an efficient and well-established business generating a proportionate amount of cash flow from sales revenue. Trends in EBITDA margins may indicate a product improvement or deterioration in a certain time period.

Emphasis on EBITDA May Narrow Your Perspective.

While useful, EBITDA does have some limitations:

- Accounting decisions still impact it: Impairments or losses of asset sales would deduct EBITDA and so it will affect its properness. It stands on a risk which is not the concern of common investor.

- No indication of debt or working capital: What is alone does not indicate anything about a certain company’s debt position, interest expenses or normal operating accounts, which are all very important indicators.

- Not a substitute for net income: Operating expenses along with non-operating expenses give the real net income that is profitability for the business. EBITDA should function as an edge to and secondary rather than substitute for net earnings analysis.

It is crucial that you should employ it in a judicious manner, in company with other ratios, to assess companies. In fact, it can complete our toolbox, but we should keep it mind that it has some unexplored gaps. Investors can get the right estimation about the performance of their target company by considering EBITDA together with other metrics such as debt-to-EBITDA ratio and net profit margins.