Banks use EBITDA because it gives a cleaner view of operating earnings and repayment capacity than net profit. EBITDA stands for Earnings Before Interest, Taxes, Depreciation and Amortisation — operating profit before interest, tax, depreciation and amortisation. It is a proxy for the ongoing cash-generating capacity of operations, stripped of financing structure and accounting choices.
Calculation (simplified):
Revenue − Cost of goods sold − Personnel − Other operating expenses = EBITDA
Or conversely: Net profit + Tax + Interest + Depreciation and amortisation = EBITDA.
Why EBITDA specifically?
The bank could use net profit. But net profit is influenced by things the bank is less interested in:
- Interest: Depends on how the company is financed — which is precisely what the bank itself influences.
- Tax: Depends on legal structure and losses carried forward from prior years.
- Depreciation: Accounting allocations, not cash expenses.
By removing these, you get a clearer picture of operations' ability to generate earnings.
EBITDA is not cash flow
This is important: EBITDA is not the same as cash flow. EBITDA ignores changes in working capital, investments and tax payments. A company can have healthy EBITDA and simultaneously run out of liquidity due to growth in receivables or inventory.
That is why EBITDA must always be read together with cash flow, working capital and debt service.
Add-backs: the grey zone
In some loan agreements it is permitted to adjust EBITDA by adding back one-off costs. This is called add-backs. It might be restructuring, severance, legal fees or similar. Add-backs can be legitimate — but they can also be abused. The bank typically tests both raw EBITDA and adjusted EBITDA.
LTM EBITDA
Covenants are most often tested on LTM EBITDA (Last Twelve Months). This means EBITDA for the most recent 12 months, rolled forward each quarter. This provides a stable measure that is less sensitive to seasonal fluctuations.