What Is EBITDA? Learn How to Calculate EBITDA

EBITDA—an acronym that stands for “earnings before interest, taxes, depreciation, and amortization”—is a measure of a company's financial performance. Business owners use EBITDA to monitor their company's cash flow and to analyze the profitability of core operations before taking into account capital expenditures, tax rates, and non-cash expenses.

EBITDA is useful for comparing the operating performances of similar businesses in the same industry. EBITDA is not part of the U.S. Generally Accepted Accounting Principles (GAAP), so there's no legal requirement for businesses to include EBITDA on their income statements.

Learn the importance of each part of the EBITDA calculation:

1. 1. Earnings: A company's earnings is the amount of income generated after subtracting operating expenses from total revenue.
2. 2. Interest: A company makes interest payments when they take on debt. EBITDA does not deduct interest from earnings, which makes it easier to compare different companies that have varying capital structures and interest expenses.
3. 3. Taxes: The EBITDA calculation does not deduct taxes from earnings because tax expenses do not necessarily reflect the performance of a business. For example, tax rates vary depending on a company's location.
4. 4. Depreciation: Depreciation expenses measure the loss in value of tangible assets, like vehicles, land, and equipment.
5. 5. Amortization: Amortization expenses measure the loss in value of intangible assets, like patents, trademarks, and copyrights. Both depreciation and amortization reflect a company's past investments rather than present-day operating profitability.

To calculate EBITDA, begin with your company’s net income (also called net profit or bottom line) and then add information from the balance sheet and income statement per the EBITDA formula:

If you've already calculated your EBIT (earnings before interest and taxes), add the depreciation expenses and amortization expenses back into the equation to calculate your company's EBITDA.

If you're looking to compare your company's operating efficiency to a competitor's, you may also use the formula for EBITDA margin. EBITDA margin is simply EBITDA divided by total revenue, as seen in the following equation:

EBITDA margin is displayed as a percentage. The higher a company's EBITDA margin, the lower its operating expenses are compared to its total revenue. Investors view a high EBITDA margin as less risky than a low EBITDA margin.

EBITDA excludes items that are mostly out of the company's control, such as taxes, capital structure, debt financing, and depreciation. The metric can help to assess cash flow, measure profitability, and inform investors:

• It helps you assess cash flow. A company’s EBITDA represents its cash flow generated by current operations.
• It allows you to measure profitability. By excluding expenses not related to a company’s core operations, EBITDA offers a clearer interpretation of a company's profits based solely on its operational performance.
• It helps investors evaluate company performance. EBITDA is particularly useful for investors looking to evaluate the financial health of two companies located in separate tax jurisdictions or with varying capital structures.

The primary flaw of EBITDA is that a company could potentially use this metric to try to obscure problems in its financial statements. This is because EBITDA does not account for changes in working capital and the costs of assets. A company with considerable debt or expensive assets could use EBITDA to inflate its valuation. To avoid this, use EBITDA as a starting point in analyzing a company’s profitability, and make sure to factor in other profitability metrics as well.

There are different metrics you can use to track your company's financial health and compose your company's financial statements:

1. 1. Gross profit: Gross profit is the amount of income left over after subtracting the cost of goods sold (COGS) from the total sales revenue. This metric indicates whether a company’s production process needs to be more or less cost-effective in comparison to its revenue.
2. 2. Net income: Calculate the net income metric by subtracting total expenses from total revenue to see exactly how much a company profits (a new profit) or loses (a net loss). A company's net income over time is a great indicator of how well or poorly its management team runs the company.
3. 3. Operating profit: To calculate operating profit or earnings before interest and taxes (EBIT), subtract operating expenses—which include overhead costs like rent, marketing, insurance, corporate salaries, and equipment—from gross profit. Investors find EBIT useful in determining a company's financial performance because it doesn't factor in items that are out of the management team's control.
4. 4. Gross profit margin: A gross profit margin is the percentage of revenue generated that's greater than the COGS. To calculate gross profit margin, divide gross income by revenue and multiply the result by 100.
5. 5. Net profit margin: Net profit margin is the ratio of net profit to total revenue expressed as a percentage. To calculate net profit margin, divide your net income by total revenue and multiply the answer by 100.
6. 6. EBITDA: This metric—which stands for earnings before interest, taxes, depreciation, and amortization—calculates a company’s operating performance by excluding all expenses that do not factor into the ongoing operations.

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