Dana Whitfield spent her first year running a commercial laundry in Kansas City convinced she had made a $1.4 million mistake.
Kettle Creek Laundry Works washes sheets and towels for eleven mid-size hotels. Dana bought the business in January, financed the tunnel washers and delivery vans with an equipment loan, and worked every Saturday for twelve months. Revenue came in at $1.85 million. Great, but bad news. Her balance sheet read: Net loss = $53,000.
She called her CPA ready to talk about shutting the thing down. He talked her through one line she had skipped past on the way to the bottom of the page. Before depreciation and interest touched the numbers, the laundry had earned $310,000.
Same business. Same year. Same twelve months of Saturdays. Two numbers that told very different stories. Let’s learn why.
What the acronym is actually doing
EBITDA stands for earnings before interest, taxes, depreciation, and amortization. It measures what a business earns from the work it does every day, before four costs that have nothing to do with washing hotel linens get subtracted.
Two formulas get you there, and both land in the same place.
EBITDA = Net Income + Interest + Taxes + Depreciation + Amortization
EBITDA = Operating Income + Depreciation + Amortization
Each item gets added back for a reason.
- Interest reflects how a business chose to fund itself, not how well it operates.
- Taxes depend on the state you registered in and the year you had.
- Depreciation and amortization are non-cash charges, accounting entries that spread the cost of assets already purchased across their useful life.
The two non-cash charges cover different ground. Depreciation applies to tangible fixed assets like Dana's washers and vans. Amortization applies to intangibles such as patents, trademarks, and capitalized software, which is why early-stage tech companies lean on the metric as hard as pipeline operators do.
Strip those four out and you get a clean view of operating performance. That is the whole idea.
Here is Dana's year, laid out as a ladder.
| Line item |
Amount |
| Revenue |
$1,850,000 |
| Cost of goods sold |
($1,110,000) |
| Gross profit |
$740,000 |
| SG&A |
($430,000) |
| EBITDA |
$310,000 |
| Depreciation and amortization |
($265,000) |
| EBIT (operating income) |
$45,000 |
| Interest expense |
($98,000) |
| Net income |
($53,000) |
Run the reconstruction the other direction, and it holds: negative $53,000 plus $98,000 of interest plus $265,000 of depreciation equals $310,000.
Her EBITDA margin comes out at 16.8 percent, calculated as $310,000 divided by $1.85 million. For an asset-heavy service business, that is respectable.
Why investors reach for it first
Cable pioneer John Malone built the metric in the 1970s to sell lenders on a growth strategy funded by debt. Leveraged buyout firms adopted it through the 1980s because a buyout changes a company's debt load and tax position anyway, so excluding interest and tax made the target easier to evaluate.
This logic still drives how the number gets used today.
1. Comparability is the first reason.
Two laundries with identical operations can post wildly different net income if one carries a loan and the other paid in cash. EBITDA normalizes that gap and lets buyers compare the operating engines directly.
2. Debt capacity is the second.
Lenders watch the debt-to-EBITDA ratio closely, and Dana's sits at 4.5 times against her $1.4 million loan. Most commercial lenders start getting uncomfortable above three. Coverage matters too, and a common benchmark holds that EBITDA should run at least twice annual interest expense. Dana clears that at 3.2 times.
3. Valuation is the third.
Business brokers price companies as a multiple of EBITDA, typically expressed as EV/EBITDA. NYU Stern's 2025 dataset put the American average at 18.6 times, though small private service businesses trade far lower, often in the three to five range.
At four times, Dana's land is worth roughly $1.24 million on paper. Her net loss suggests it is worth nothing.
The part that should make you cautious
Warren Buffett once asked whether management thinks the tooth fairy pays for capital expenditures. This question explains the biggest weakness in the metric.
Depreciation gets added back because no cash moved this year. Those tunnel washers still wear out. Dana will replace two of them within six years, and sustaining the equipment base costs her roughly $180,000 annually in maintenance capital expenditures. Subtract that plus her $98,000 interest bill from $310,000 of EBITDA, and $32,000 of real cash remains.
The depreciation charge was a forecast of a bill that arrives later. Adding it back does not cancel it.
EBITDA also ignores working capital. Dana's hotels pay on 60-day terms, which means a good sales month can drain her checking account. Operating cash flow captures that movement. EBITDA never sees it.
Then there is the manipulation problem. EBITDA carries no GAAP definition, so companies calculate it however they like. WeWork's 2018 IPO prospectus introduced "Community Adjusted EBITDA," which excluded general, administrative, sales, and marketing costs on top of the usual four. The SEC now requires public companies to reconcile EBITDA back to net income for exactly this reason.
Watch for one specific red flag as a reader of financial statements. When a company that never mentioned EBITDA suddenly leads with it, capital costs or debt have usually started to bite.
How to use it this week
Pull your last income statement and calculate three numbers. Start with EBITDA using either formula. Divide it by revenue for your EBITDA margin. Then divide total debt by EBITDA.
Debt-to-EBITDA = Total Debt ÷ EBITDA
Under three means comfortable. Above four means a lender will ask questions before writing anything.
Then do the honest version. Subtract your annual maintenance capex and your interest payments from EBITDA. The remainder is closer to what the business actually hands you.
