EBITDA, or earnings before interest, taxes, depreciation, and amortization, is a measure of a company’s financial performance and is sometimes used as an alternative to net income.
Some analysts believe that EBITDA provides a more accurate measure of a company’s profits and operational efficiency than net income. Others, however, think that EBITDA can be misleading, since it ignores company expenses like debt and depreciation.
Here’s what you need to know about EBITDA, how this metric is calculated, and what it can — and can’t — tell you about your business.
Key Points
• EBITDA is used to assess a company’s core profitability by excluding non-operational expenses like interest, taxes, and non-cash items like depreciation and amortization.
• EBITDA is not a standardized accounting measure, meaning companies can calculate it differently.
• The formula for EBITDA is Net Income + Taxes Owed + Interest + Depreciation + Amortization.
• Typically, a high EBITDA represents strong operational profitability.
What Is EBITDA?
EBITDA is an acronym that stands for earnings before interest, taxes, depreciation, and amortization. In other words, it tells you the earnings that a business has generated prior to any debt interest expenses, tax payments, and depreciation/amortization costs of the business.
EBITDA doesn’t factor these values in because they are outside of management’s operational control. By adding these values back to net income (gross business income minus all business expenses), many analysts believe that EBITA is a better measure of company performance since it is able to show earnings before the influence of accounting and financial deductions.
EBITDA may be calculated by investors or when you’re applying for a small business loan to estimate how well your company will be able to pay its bills and maintain or increase net income.
Here’s a closer look at each letter of this acronym.
Earnings
Earnings are the profit a business makes off of its core operations. It’s calculated by subtracting total expenses from total revenue. Operating expenses include rent, salaries, the cost of goods sold, and other general and administrative expenses. This number is your operating income.
Finally, non-operating expenses, including taxes, interest, depreciation, and amortization, are subtracted to arrive at net earnings or net income.
Keep in mind that with EBITDA, you add back interest, taxes, depreciation, and amortization to net income to arrive at earnings.
Interest
Interest refers to the cost a business incurs from borrowing money, such as loans or bonds. It is excluded from EBITDA because it reflects financing decisions, not the core operations of the business. This allows EBITDA to focus on the company’s operational performance before financial obligations.
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Taxes
Each locality has different tax laws which can impact which kinds of taxes you pay and how much. Depending on where a business is located, it may have a dramatically different tax burden than another company with the same amount in sales.
To better compare companies, EBITDA removes the effect of taxes on earnings by adding those expenses back into net income. Doing so makes it easier to compare the performance of two or more companies operating in different states, cities, or counties.
Depreciation
Depreciation is the process of spreading out the cost of a tangible asset over the course of its useful life. While depreciation does cost a business money (as machinery and vehicles do wear out), it’s a non-cash expense that depends on past investments the company has made and not on the current operating performance of the business. Therefore, EBITDA doesn’t factor it in.
Amortization
The difference between amortization vs depreciation is that amortization is the depreciation of intangible items, such as patents or licenses, which also have a limited useful life due to expiration. Amortization is an expense that is reported on a company’s financial statements, but, since it isn’t directly related to a business’s core operations, EBITDA doesn’t factor it in.
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EBITDA Formula
To calculate EBITDA, there are two commonly used EBITDA formulas.
Option 1:
Start with net income (the bottom line of the income statement), and then add back the entries for taxes, interest, depreciation, and amortization.
EBITDA = Net income + Taxes Owed + Interest + Depreciation + Amortization
Option 2:
Alternatively, you can start with operating income (also referred to as operating profit or EBIT — earnings before interest and taxes). Operating income is the amount of revenue left after deducting the direct and indirect operating costs from sales revenue. If you add depreciation and amortization to operating income, you get EBITDA.
EBITDA = Operating Income + Depreciation + Amortization
EBITDA Example
Coca-Cola Company, EBITDA example:
| Sales Revenue | 38,726 |
| Sales Growth | 17.25% |
| COGS (including D&A) | 15,508 |
| Depreciation | 1,277 |
| Amortization | 175 |
| Gross income | 23,218 |
| Non-operating income expense | 2,076 |
| Interest expense | 747 |
| Pretax income | 12,425 |
| Income tax | 2,621 |
| Net income | 9,771 |
| EBITDA | 10,697 |
Notice how EBITDA is more than net income. Sometimes less honest companies try to persuade investors that they are more profitable than they are by emphasizing their EBITDA number more than their net income number.
Pros and Cons of EBITDA
Here, see how the potential advantages and disadvantages of EBITDA compare.
| Pros of EBITDA | Cons of EBITDA |
|---|---|
| A better measure of a company’s operational efficiency than net profit | Does not reflect a company’s actual cash flow |
| Can give an analyst a quick estimate of the value of the company | Can give the illusion that interest and taxes are optional for a company |
| Can be used to compare companies against each other and industry averages | Can be used to distract investors from the lack of real profitability |
EBITDA can be a valuable measure of a company’s financial performance and operational efficiency. Because EBITDA adds back interest, taxes, depreciation, and amortization (expenses that don’t directly reflect a company’s decisions) to a company’s net income, it shines a light on a business’s ability to generate cash flow from its operations.
When calculating EBITDA, the only costs subtracted from revenue are ones that are directly linked to the company’s operations (such as rent, salaries, marketing, and research). Capital structure decisions, which are reflected in depreciation, amortization, and debt expenses, aren’t included. As a result, it gives analysts a way to more accurately compare performance between companies with different capital structures. In addition, business owners use it to compare their performance against their competitors.
However, EBITDA doesn’t reflect a business’s actual net earnings. Some analysts are skeptical of EBITDA because it presents the company as if it has never paid any interest or taxes. It also excludes depreciation and amortization expenses, even though machines, tools, and other assets lose their value over time, and copyrights and patents expire. EBITDA fails to account for these costs.
EBITDA can also cover up or shift attention away from high debt levels. Indeed, it’s possible to report a strong EBITDA while stating negative profits at the bottom line.
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History of EBITDA
EBITDA came into prominence in the 1980s when many investors were doing leveraged buyouts of distressed companies that needed financial restructuring. They used EBITDA to calculate quickly whether these companies could pay back the interest on these financed deals.
The use of EBITDA increased during the dot-com boom, when analysts and managers used it to show that expensive assets and debt loads were obscuring a company’s actual growth numbers.
EBITDA is now commonly used to compare the financial health of companies and to evaluate businesses with different tax rates and depreciation policies.
Alternatives to EBITDA
Here are some other ways to track information instead of EBITDA.
EBT
Earnings before tax (EBT) measures how profitable a company is before you consider its tax burden. EBT is useful when comparing two companies in the same industry but that exist in different states. By removing tax liabilities, investors can use EBT to evaluate a firm’s operating performance after eliminating a variable outside of its control.
Operating Cash Flow
Operating cash flow measures how much cash is generated by a company’s normal business operations. Operating cash flow indicates whether a company can generate sufficient positive cash flow to maintain and grow its operations. If not, it may require external financing.
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EBIT
The difference between EBIT vs EBITDA is that EBIT (earnings before interest and taxes) doesn’t add depreciation and amortization back to net income. EBIT considers these costs as necessary expenses to consider when analyzing a company.
Revenue
Revenue (also referred to as sales or income) consists of all income generated by a business’s core activities before expenses are taken out. It includes both paid and unpaid invoices.
When thinking about EBITDA vs revenue, revenue measures sales activity, while EBITDA measures how profitable the business is. Revenue is calculated by adding up income from all business operations, whereas EBITDA takes that revenue and then subtracts expenses in order to measure profit.
Net Income
Net income (also called net earnings) is how much a company makes after subtracting all expenses, including cost of goods sold, general and administrative expenses, operating expenses, depreciation and amortization, interest on debt, taxes, and other expenses. It is a useful number for investors to assess how much revenue exceeds the expenses of an organization.
The Takeaway
EBITDA is a way to quickly gauge how a business is performing with its core operations, but it excludes interest, taxes, depreciation, and amortization. EBITDA can be helpful for seeing how your business performs from year to year and how it compares to the industry averages, but it does not reflect its real income. That’s why if you’re exploring business loans or looking to attract an investor, EBITDA will likely be one of several metrics to consider.
If you’re seeking financing for your business, SoFi can help. On SoFi’s marketplace, you can shop top providers today to access the capital you need. Find a personalized business financing option today in minutes.
FAQ
What makes EBITDA important?
EBITDA is a useful metric for understanding a business’s ability to generate cash flow for its owners and for judging a company’s operating performance.
How is EBITDA calculated?
The most common way to find EBITDA is by starting with net income and adding back interest, taxes, depreciation, and amortization.
What is a typical EBITDA?
There is no typical EBITDA because companies of different sizes in different industries vary widely in their financial performance. The best way to determine if your company’s EBITDA is typical is to compare it with the EBITDA of your peers — companies of similar size in the same industry and sector.
Is EBITDA a good indicator of profitability?
EBITDA can be a good indicator of profitability. However, it doesn’t account for capital expenditures, debt, or changes in working capital, so it may not fully reflect a company’s overall financial health or long-term profitability.
What is a good EBITDA?
EBITDA varies by industry, but generally, a higher EBITDA indicates strong operational profitability. A healthy EBITDA margin (EBITDA divided by revenue) is typically around 10-20%, though this will also vary depending on the industry.
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