EBITDA

Article byHimani Bhatt
Edited bySusmita Pathak
Reviewed byDheeraj Vaidya, CFA, FRM

EBITDA Meaning

EBITDA or Earnings before interest, taxes, depreciation, and amortization is a business valuation metric to assess the financial strength of the organization. Business owners utilize it to compare market performance with their rivals. Moreover, a positive or negative EBITDA explains the effect of the company’s capital structure on its cash flows and bottom line.

It displays the financial results of a firm, except capital investments, like equipment, property, and plant. Please note that it is not recognized by the Generally Accepted Accounting Principles (GAAP).

Key Takeaways

  • EBITDA is a financial indicator to predict the long-term efficiency of the company and evaluate its capability of future funding repayment, which can be negative or positive.
  • It is calculated by adding the company’s net earnings, taxes, depreciation, amortization, and interest expenses.
  • It is different from EBIT as the former offers an overview of the company’s total income while the latter is a metric that reveals its approximate earnings.
  • The EBITDA margin formula certainly explains the profit-making capability of the firm in a fiscal year.

EBITDA Explained

EBITDA, whether negative or positive, offers the accountants a quick review of the firm’s worth, and in some situations, businessmen also use the adjusted EBITDA metric. Furthermore, numerous privatized equity firms use it to analyze similar companies in the same sector precisely. It is an important method for organizations with continuous growth chances seeking investors.

Please note that it assists in stating the corporate profitCorporate ProfitCorporate profit, or ‘profit after tax, is the net income received from the business after deducting direct expenses, indirect expenses and all the applicable taxes from the total revenue generated by the company during the year.read more of the enterprise while determining the latter’s performance, ruling out its operating expensesOperating ExpensesOperating expense (OPEX) is the cost incurred in the normal course of business and does not include expenses directly related to product manufacturing or service delivery. Therefore, they are readily available in the income statement and help to determine the net profit.read more. It also calculates the business’s debt service coverage ratio. However, this is different from Earnings Before Interest and Taxes(Earnings Before Interest And Taxes)Earnings before interest and tax (EBIT) refers to the company's operating profit that is acquired after deducting all the expenses except the interest and tax expenses from the revenue. It denotes the organization's profit from business operations while excluding all taxes and costs of capital.read more. While EBIT states the comapny’s estimated earnings, the former offers a snapshot of its gross income.

For best results, the adjusted EBITDA formula helps review the firm for mergers and acquisitions as it states positive or negative cash flow. It deletes numerous irregular, non-recurrent, and one-time elements from earnings before interest, taxes, depreciation, and amortization. Adjusted EBITDA removes the cost of goods soldCost Of Goods SoldThe Cost of Goods Sold (COGS) is the cumulative total of direct costs incurred for the goods or services sold, including direct expenses like raw material, direct labour cost and other direct costs. However, it excludes all the indirect expenses incurred by the company. read more from the final calculation.

Furthermore, it benefits commercial activities like downsizing, budgeting, creating an exit plan, and investing. The metric is a variation of the operating income, aka EBIT, which eliminates some non-cash expenses. Additionally, investors can use this metric to evaluate the firm when it does not make a net profit.

Business people can also use EBITDA multiple to analyze their corporation’s enterprise value to the yearly earnings before interest, taxes, depreciation, and amortization.

How To Calculate EBITDA?

So, here is the EBITDA Formula to calculate whether your company has a positive or negative cash flow,

EBITDA= Net earnings + Interest + Taxes + Depreciation + Amortization

Generally, businessmen must eliminate the firm’s expenses besides net income, interest, taxes, depreciation, and amortization

While net earnings may incorporate net wages or losses, interest occasionally comprises cumulative interest. Likewise, taxes involve tax credits at times. They differ as per the region of business operations.

DepreciationDepreciationDepreciation is a systematic allocation method used to account for the costs of any physical or tangible asset throughout its useful life. Its value indicates how much of an asset’s worth has been utilized. Depreciation enables companies to generate revenue from their assets while only charging a fraction of the cost of the asset in use each year. read more consists of tangible assetsTangible AssetsTangible assets are assets with significant value and are available in physical form. It means any asset that can be touched and felt could be labeled a tangible one with a long-term valuation.read more, a part of whose price is allotted as the depreciation amount in the income statementThe Income StatementThe income statement is one of the company's financial reports that summarizes all of the company's revenues and expenses over time in order to determine the company's profit or loss and measure its business activity over time based on user requirements.read more of each fiscal yearFiscal YearFiscal Year (FY) is referred to as a period lasting for twelve months and is used for budgeting, account keeping and all the other financial reporting for industries. Some of the most commonly used Fiscal Years by businesses all over the world are: 1st January to 31st December, 1st April to 31st March, 1st July to 30th June and 1st October to 30th Septemberread more. On the contrary, amortization involves allocating the organization’s intangible assetsThese Intangible AssetsIntangible Assets are the identifiable assets which do not have a physical existence, i.e., you can't touch them, like goodwill, patents, copyrights, & franchise etc. They are considered as long-term or long-living assets as the Company utilizes them for over a year. read more during its lifespan. Assumptions considering beneficial economic life, depreciation method, and salvage value heavily impact depreciation and amortization.

Please note that an organization might have a positive or negative EBITDA indicating productivity or low operating cash flow for a firmOperating Cash Flow For A FirmCash flow from Operations is the first of the three parts of the cash flow statement that shows the cash inflows and outflows from core operating business in an accounting year. Operating Activities includes cash received from Sales, cash expenses paid for direct costs as well as payment is done for funding working capital.read more, respectively.

EBITDA Margin

It elucidates the relationship of the company’s gross income with its overall profit. Simply put, this metric implicates how much net profit the company can make in a financial year. It is a non-registered metric in the financial statement of the enterprise, so market analysts and investors must compute it themselves.

Businessmen must directly compare their company to another enterprise with an adjusted EBITDA formula to get correct interpretation. Being a non-GAAPGAAPGAAP (Generally Accepted Accounting Principles) are standardized guidelines for accounting and financial reporting.read more measure, earnings before interest, taxes, depreciation, and amortization may be illusive.

The calculation is as follows,

EBITDA Margin = Earnings before Interest, Taxes, Depreciation, and Amortization/ Gross Revenue

More importantly, the corporation with a comparatively higher margin is more likely to have relevant growth prospects by expert purchasers.

Moreover, EBITDA multiple basically assesses if the enterprise is under or overvalued.

Examples

Let’s go through the following examples.

Example #1

Say, a company ABC Co. has net earnings worth 2000000 and pays a total interest of $350000. The depreciation and amortization amount equals to a total of $150300 with taxes paid worth $120000.

Now, investors use the EBITDA Formula to predict a positive or negative outcome in numbers,

 Net earnings + Interest + Taxes + Depreciation + Amortization

= $2000000 + $350000 + $150300 + $120000

= $2620300

Hence, the earnings before interest, taxes, depreciation, and amortization of ABC Co. equals to $2620300.

Example #2

OneSpaWorld Holdings Ltd., (OSW) declared its fiscal 2022 and fourth-quarter preliminary expectations with initiating fiscal 2023 interpretation as well. Moreover, OSW provides health and wellness items and services in the destination resorts and on the board cruise ships.

The expected range of its earnings before interest, taxes, depreciation, and amortization for the quarter is $14.3 million – $17.3 million. Actually, it is more than double the amount of fiscal year 2021 and a 26.4% increase from 2019. Additionally, the expected range of its Earnings before interest, taxes, depreciation, and amortization for 2022 and 2023 is $44 million – $47 million and $64.0 million – $70.0 million.

Pros And Cons Of EBITDA

ProsCons
Helpful in downsizing, devising an exit plan, budgeting, and investingNot recognized by International Financial Reporting Standards or GAAP
Helps comprehend the firm’s underlying business income as compared to similar enterprisesLack of consideration towards regarding capital expenditures
Neutral towards the capital structurePossibly misleading
Proper indicator of the enterprise’s potential and current positionHides financial burdens
Decreased risk of a few aspectsIgnores the debt cost
No debt transferBusinessmen might not get a loan

Frequently Asked Questions (FAQs)

Is EBITDA Operating Profit?

No, EBITDA is not operating profit. Rather, EBIT is generally utilized as a metric; in some situations, it is equivalent to the GAAP standard operating income. As the name indicates, EBIT portrays total earnings, excluding the impact of taxes and debt interest.

What Is Adjusted EBITDA?

Adjusted EBITDA is a metric that considers the company’s earnings and adds back its taxes, depreciation rates, and interest charges.

Moreover, it also adds some other adjustments to the measure. Its purpose is to achieve a normal number not affected by irregular losses, gains, or other elements.

Why Is EBITDA Important?

EBITDA formula is important because it assists businesses in comparing and evaluating profitability with similar firms and sectors and can be positive or negative. This way, it removes the impact of accounting, government, or financing decisions to offer clearer and fresh evidence of the income. In addition, the metric displays the firm’s worth to prospective investors and buyers to showcase its growth opportunities.

EBITDA Explained in Video

 

This article has been a guide to EBITDA and its Meaning. Here we discuss EBITDA Formula, EBITDA Margin, Its examples, Pros & Cons, & Adjusted EBITDA. You may also have a look at the following articles to learn more about Financial Analysis –

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