We cannot compare the savings of two individuals with each other because the spending patterns might be different. They might be spending different amounts on mortgages, on lifestyle expenses, on medical expenses, or stuff like that. Because no reasonable person can compare the savings of someone who is single versus someone who is running a family with three kids.
Thus, if you want to make comparisons, you can say, “Hey, these two people are spending different amounts on, let’s say, mortgage expenses.” Then you can say, “What is their income before both of them have paid for mortgage expenses?” Same can be said about other expenses. And then, if you keep neutralizing differences, you might arrive at a common point. Sometimes that common point might look like “Savings Before XYZ Expense.” Sometimes, both of them are so similar that they can be similar right away at saving spot.
Same is the thing with businesses. You cannot compare companies by net income because they might have spent differently on depreciation, amortization, interest, taxes, etc. That’s why when comparing companies, we tried to see which metric would be proper to judge these companies against each other. Would it be EBITDA? Would it be EBIT? Would it be net Income?
The goal is to include operating expenses and exercise discretion while dealing non operating expenses. Goal is to account for how they run show but not get disoriented by unsual things. How they manufacture, research or manufacture is some important context that we do not want to miss out on inside the metric. Because the variation in that within the comps are valuable, while non operating expenses are corrosive to accurate analysis. You WANT operational variation captured in your metric. You DON’T WANT non-operating distortions.
you can think of EBITDA, EBIT, or other metrics as some preservatives. Things that prevent corrosion in your analysis.
The more deductions, the more niche downed the metric. The less deductions, the more generic and cross compatible the metric. And we need these metrics to be able to carry out valuation using comparables.
From Claude
What Causes “Corrosion” in Analysis?
Capital structure contamination – Company A looks worse than Company B not because it operates poorly, but because it carries more debt. Interest expense corrodes the comparison.
Tax jurisdiction distortion – Company C shows lower earnings not due to operational weakness, but because it’s headquartered in a high-tax country. Tax expense corrodes the analysis.
Accounting policy interference – Company D depreciates assets faster than Company E for the same equipment. Depreciation choices corrode operational comparisons.
One-time event pollution – Company F took a restructuring charge. This one-time expense corrodes your view of normal operations.
The Preservative Effect
Each metric acts as a preservative at different levels:
EBITDA = Heavy-duty preservative
- Strips out depreciation, amortization, interest, taxes
- Maximum protection from corrosion
- Preserves only the core operational performance
EBIT = Moderate preservative
- Keeps depreciation/amortization (because asset intensity matters)
- Removes interest and taxes
- Preserves operational economics including capital intensity
Adjusted EBITDA = Industrial-strength preservative
- EBITDA plus removes stock-based comp, one-time items, etc.
- Sometimes over-preserves (companies can abuse this)
- Risk: you might remove so much that you’re preserving something that doesn’t reflect reality