The metric is constructed on operating profit, to which depreciation is added. The logic is that depreciation is a non-cash expense: it reflects the write-off of previously acquired assets rather than current period outflows.
The purpose is comparability. By excluding interest, taxes, and depreciation, the metric removes the impact of financing structure, tax regime, and accounting policy, leaving the result of operations itself. This allows comparison of companies with different debt loads and different approaches to fixed asset accounting.
Primary application is in assessing debt burden through the debt-to-EBITDA ratio and in the multiple relating company value to this metric.
Limitations are significant. EBITDA is not a cash flow: it does not account for working capital needs and capital expenditures, and for capital-intensive businesses such exclusion distorts the picture—worn equipment must be replaced with real money. The metric is also not part of standard reporting and is calculated differently by companies, so when comparing, verify the methodology.