Association for Financial Professionals (AFP) Practice Exam

In the context of cash management, what does EBITDA stand for?

1. Earnings Before Income, Taxes, Depreciation, and Amortization

2. Earnings Before Interest, Taxes, Dividends, and Allowances

3. Earnings Before Interest, Taxes, Depreciation, and Amortization

4. Estimated Benefits in Treasury, Debts, and Assets

The correct answer is: Earnings Before Interest, Taxes, Depreciation, and Amortization

EBITDA stands for "Earnings Before Interest, Taxes, Depreciation, and Amortization." This metric is widely used in cash management and financial analysis as it provides insight into a company’s operational performance without the effects of financing and accounting decisions. Focusing on what EBITDA represents, it provides a clear picture of a company’s profitability from its core operations. By excluding interest, it removes the effects of debt, making it easier to compare companies regardless of their capital structures. Excluding taxes also provides a clearer view of operational performance without the influence of tax rates and policies. Furthermore, by not accounting for depreciation and amortization, EBITDA reflects cash flows from operations as it illustrates earnings generated by the core business functions, isolating the effects of asset wear and accounting practices. This measure helps stakeholders, including investors and management, assess the company’s financial health and capacity to generate cash, which is crucial for effective cash management. In the context of evaluating operational efficiency and funding capabilities, EBITDA is a crucial indicator. The other definitions provided in the options present misunderstandings of the actual components that EBITDA comprises or include terms that do not apply to standard financial metrics, making them incorrect.