EBITDA: Meaning, Formula, Calculation, Example & Benefits

What is EBITDA?

EBITDA, or Earnings before Interest, Taxes, Depreciation, and Amortization, is a different measure of profitability than net income. EBITDA, which includes depreciation and amortization as well as taxes and debt service expenses, seeks to depict the cash profit created by the company’s activities. EBITDA is not a GAAP-recognized number. Some public firms provide EBITDA in their quarterly results as well as adjusted EBITDA statistics, which often exclude extra expenditures such as stock-based compensation. The increased emphasis on EBITDA by firms and investors has sparked criticism that it overstates profitability.

Geeky Takeaways:

• Earnings before interest, taxes, depreciation, and amortization (EBITDA) is a metric measuring fundamental business performance.
• To calculate EBITDA, add interest, tax, depreciation, and amortization expenditures to net income.
• EBITDA has been used as an important metric by shareholders and investors to make business decisions.
• Some critics, notably Warren Buffett, believe EBITDA is meaningless since it excludes depreciation and capital expenditures.

Why EBITDA?

1. Management: EBITDA measures how successfully a firm manages its day-to-day operations, including key costs like the cost of goods sold. As such, it provides a fairly accurate picture of a company’s current health and prospects. In certain circumstances, it is more equitable than gross profit or net income.

2. Profitability: EBITDA is arrived by including interest, taxes, depreciation, and amortization to net income. EBITDA may be used to analyze and evaluate organizations’ underlying profitability, regardless of depreciation assumptions or financing options.

3. Ratios: EBITDA, like earnings, is commonly used in valuation ratios, especially when paired with enterprise value as EV/EBITDA, also known as the enterprise multiple.

4. Study of Assets: EBITDA is commonly employed in the study of asset-intensive industries with a large amount of property, plant, and equipment and substantial non-cash depreciation expenses.

EBITDA Formulas

If a corporation does not declare EBITDA, it is easy to calculate using its financial statements. Calculations may be made easier with software such as Excel. The income statement includes earnings (net income), taxes, and interest, whereas depreciation and amortization statistics are often found in the notes to operating profit or on the cash flow statement. There are two EBITDA estimates, one based on net income and the other on operating income, and both provide about the same result.

EBITDA = Net Income + Taxes + Interest Expense + D&A

or

EBITDA = Operating Income + D&A

where,

D&A= depreciation and amortization

Example of EBITDA

Calculate EBITDA from the following items in a company where,

Net Income = ₹20,000,000

Depreciation & Amortization = ₹10,000,000

Interest Expense = ₹5,000,000

Taxes = ₹5,000,000

Solution:

Using the formula

EBITDA = Net Income + Depreciation & Amortization + Interest Expense + Taxes

EBITDA = ₹20,000,000 + ₹10,000,000 + ₹5,000,000 + ₹5,000,000

EBITDA = ₹40,000,000

History of EBITDA

EBITDA was invented by Liberty Media Chairman John Malone, one of the few investors with a track record that rivals Buffett’s. The cable industry pioneer developed the statistic in the 1970s to assist lenders and investors understand his leveraged expansion plan, which used debt and reinvested revenues to reduce taxes.

During the 1980s, investors and lenders participating in leveraged buyouts (LBOs) considered EBITDA valuable in determining if the targeted firms were profitable enough to service the debt that was projected to be committed in the transaction. Since a takeover would most certainly result in a change in the capital structure and tax obligations, it seemed appropriate to deduct the interest and tax expenditure from earnings. EBITDA became popular during the dotcom bubble, when some firms utilized it to inflate their financial success.

Benefits of EBITDA

1. Earning Potential: It can provide information about the company’s earnings potential. It is an important metric for attracting potential buyers and investors. The EBITDA figure allows investors to calculate the return on their investment in the firm.

2. Financial Well-Being: EBITDA is used by investors and creditors to determine the success of a company’s basic activities without regard for tax consequences or the cost of the capital structure. Furthermore, they can easily determine whether or not the business’s operations and concepts are effective in the real world.

3. Fundamental and Easy: Compared to other financial statistics, earnings before interest and taxes are straightforward to compute and understand. So, as a user, the first metric that gives a fundamental knowledge of the firm is EBITDA.

4. Easy Comparability: It improves comparability between firms by excluding the interest and tax component from the calculation, which varies between companies and industries and influences profitability.

5. Analysis of Patterns: The approach of EBITDA earnings before interest and taxes is also an effective indicator for analyzing historical patterns. Historical data is commonly utilized to analyze current firm performance and estimate future outcomes. This facilitates educated financial decisions.

Criticisms of EBITDA

1. Inclusion of Depreciation: Depreciation is considered while calculating earnings before interest and taxes. When comparing data from various sectors, depreciation discrepancies will occur. For example, if a person compares the earnings before interest and taxes of a company with a significant amount of fixed assets to those of a company with few fixed assets, the company with fixed assets will have lower earnings before interest and taxes because the expense reduces net income or profit.

2. Dependance of Debt: Companies that rely heavily on debt incur significant interest expenses. Earnings before interest and taxes do not account for such interest expenses, resulting in an inflating of the company’s earnings potential. Investors may be misled if interest expenditure is not taken into account, as poor sales performance or lower cash flow may have led to the firm taking out large loans. However, EBITDA fails to attract the attention of investors to such significant indebtedness.

3. No Inclusion of Cash Flows: EBITDA does not represent the business’s cash flows. Cash flow details are an important sign of whether a firm can pay its short- and long-term financial obligations, which will determine its future growth chances.

4. No Tax Planning: This strategy is ineffective for tax planning since it does not take into consideration the tax due, which is critical when making financial decisions.

5. Easily Manipulated: The procedure is prone to data manipulation and deception in order to create a lucrative picture of the firm. It distorts accounting processes, such as spending capitalization and revenue recognition standards, which are commonly used in businesses. As a result, prior to implementation, it is critical to thoroughly review the books of accounts.

EBITDA vs. EBIT vs. EBT

Basis	EBITDA	EBIT	EBT
Definition	Profit excluding interest, taxes, depreciation, and amortization expenses.	Profit excluding interest and tax expenses.	Profit excluding tax expenses.
Formula	Revenue – COGS – Operating Expenses + Depreciation + Amortization	Revenue – COGS – Operating Expenses	Revenue – COGS – Operating Expenses – Other Expenses + Other Income
Operational Insight	A rough measure of profitability is calculated by adding back depreciation and amortization to EBIT.	A measure of operating profitability excluding finance expenses.	A look at profitability before taxes.
Degree of Separation from Net Income/Profit	Excludes finance, taxes, and capital depreciation from operating profits.	Excludes the impact of finance and taxes on operating profitability.	Closer to net income, excluding taxes.
Uses and Applications	Valuation, investor analysis, and company comparison, excluding financing and tax effects.	Operational analysis, valuation, and corporate comparison.	Examining profitability and tax approaches.
Tax Impact	Ignores the effect of taxes, financing, depreciation, and amortization on operating earnings.	Ignores tax and finance implications in favor of operational earnings.	Emphasizes the impact of taxes, not finance, on total earnings.

EBITDA vs. Operating Cash Flow

1. Operating cash flow is a better measure of a company’s cash generation since it adds non-cash expenses (depreciation and amortization) to net income while also accounting for changes in working capital, such as receivables, payables, and inventories, that use or produce cash.

2. Working capital trends play a vital role in determining how much cash a firm generates. If investors exclude working capital changes from their research and rely exclusively on EBITDA, they risk missing clues—for example, challenges with receivables collection—that might hamper cash flow.

EBITDA – FAQs

What is EBITDA?

EBITDA, or earnings before interest, taxes, depreciation, and amortization, is a different measure of profitability than net income. EBITDA, which includes depreciation and amortization as well as taxes and debt service expenses, seeks to depict the cash profit created by the company’s activities.

What is amortization?

Amortization is the process of gradually depreciating the book value of a company’s intangible assets. Amortization is shown on a company’s income statement. Intellectual property (patents or trademarks) and goodwill are examples of intangible assets.

What is good EBITDA?

EBITDA is a measure of a company’s profitability; higher is typically better. From the standpoint of an investor, a “good” EBITDA is one that gives further insight into a company’s performance while not losing sight of the fact that the statistic excludes cash outlays for interest and taxes, as well as the ultimate cost of replacing its tangible assets.

What is the formula of EBITDA?

EBITDA = Net Income + Taxes + Interest Expense + D&A

or

EBITDA = Operating Income + D&A

Does EBITDA includes cash flows?

EBIT does not represent the business’s cash flows. Cash flow details are an important sign of whether a firm can pay its short- and long-term financial obligations, which will determine its future growth chances.