What is Earnings Before Interest, Taxes, Depreciation, and Amortization (EBITDA)?

EBITDA Meaning

EBITDA is an important financial metric used to measure a company’s operating profitability. EBITDA refers to Earnings before Interest, Taxes, Depreciation, and Amortisation. It helps gauge a company’s financial performance and is often used as an alternative to net profit.

It is a useful tool for investors, creditors and other stakeholders as it provides an indication of a company’s underlying profitability and also represents the cash profit generated by the company’s operations.

However, it only offers a myopic view of financial performance. This is because it does not take into account the company’s capital investments and expenses related to the company’s debts, non-cash depreciation and amortization expenses. The major focus is laid on the company’s operating decisions.

EBITDA measures the company’s operating profit excluding non-operating expenses such as interest expenses or finance costs, taxes, depreciation, and amortization. Here’s a look at the exclusions made while calculating the EBITDA:

Interest: It is the expense incurred by a business on payment of interest on loans and debts. It is also called Finance cost.

Taxes: It is the amount of direct and indirect tax a business is liable to pay to the state and central government.

Depreciation: It refers to the non-cash expenses incurred for the maintenance of various assets.

Amortisation – It refers to capitalizing the value of intangible assets such as copyrights and patents over time.

How is EBITDA different from net income?

As mentioned above EBITDA is a measure of a company’s operating profitability and is a proxy for the cash flow generated from operations. On the other hand, net income or net profit is a company’s aggregate earnings. It helps gauge the company’s earnings per share. Generally, net income is a more reliable financial metric as it considers all important parameters for calculation purposes.

EBITDA non-operating and non-cash expenses, and can show a company’s financial performance without taking into consideration its capital structure. Net profit is calculated after deducting all the operating and non-operating, cash and non-cash expenses from the revenue.

How to Calculate EBITDA?

Generally, EBITDA is calculated by subtracting expenses other than interest, taxation, depreciation and amortisation from its net profit. It is not specifically mentioned in the company’s books of accounts and hence, it has to be calculated manually.

There are two formulas to calculate EBITDA, they are:

• EBITDA = Net profit + Interest + Taxes + Depreciation + Amortisation
• EBITDA = Operating income + Depreciation + Amortisation

It is to be noted that EBITDA is not a recognised metric by US GAAP or the International Financial Reporting Standards (IFRS).

Let us understand the EBITDA calculation with an example. Suppose a company’s profit and loss account shows below data:

As per the above-mentioned Profit & Loss statement, the company’s depreciation and amortisation is Rs 6,000, interest expense is Rs 2,000.

EBITDA Formula:

EBITDA = Net income + interest + taxes + depreciation + amortisation

EBITDA = 27,750 + 2,000 + 9,250 + 6,000

= Rs 45,000

Be very careful when using various values for calculation. Check for the accuracy of the data you use. Have your financial records updated from time to time.

A feasible way to know the favorability of the derived EBITDA, consider calculating the EBITDA margin.

What is EBITDA margin?

To determine whether a company is generating a good amount of EBITDA, you need to check its EBITDA margin. Also known as Operating margin, EBITDA margin indicates the company’s profitability ratio. It shows the relationship between a company’s aggregate earnings and total revenue generated.

EBITDA margin measures the EBITDA as a percentage of revenue. The operating margin of a company is compared with that of peer companies operating in the same industry.

Here’s how you can calculate a company’s EBITDA margin:

EBITDA margin = EBITDA / Revenue

Continuing with the above example, the EBITDA margin will be:

EBITDA margin in % = (45,000 / 1,05,000) X 100

= 42.85%

Typically, the EBITDA margin depicts the proportion of a company’s gross profit that is consumed by operating expenses. A higher EBITDA margin value indicates a company’s relatively lower risk with strong financials.

What is Adjusted EBITDA?

Adjusted EBITDA does away with all irregularities and standardises a company’s cash flow and income. This standardisation helps you draw comparisons between two companies.

For accurate of adjusted EBITDA, you need to remove one-time, non-recurring and infrequent costs. These costs do not have a direct impact on the company’s regular operations. Following is a list of costs that are removed while calculating adjusted EBITDA:

• Non-cash expenses
• Write-down of assets
• Compensation in the form of shares
• Litigation cost
• Unrealised one-time losses or gains
• Foreign exchange gains or losses

Conclusion

EBITDA is a useful metric that provides valuable insight into a company’s financial health. It is a metric used to compare the financial performances of different companies. However, EBITDA should not be solely used to evaluate a company as it does not account for certain factors such as capital structure, taxes, and non-recurring expenses.