What Does EBITDA Mean?

EBITDA measures operating profitability by excluding interest, taxes, depreciation, and amortization to highlight core business performance. Review formulas, examples, comparisons with EBIT and EBT, along with criticisms and practical business context.

By Douglas Wade, Attorney

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Table of Contents

1. Introduction

2. EBITDA: What is it?

3. Calculations and Formulas for EBITDA

4. What Is EBITDA Really Telling You?

5. EBITDA Example

6. EBITDA’s History

7. EBITDA Criticisms

8. Comparing EBITDA, EBIT, and EBT

9. How Is EBITDA Calculated?

10. How Does a Good EBITDA Look?

11. What Makes EBITDA Different From EBITA?

12. Are EBITDA & Gross Profit the Same?

13. What Is EBITDA Amortization?

14. Conclusion

Introduction

Consider investing in a company or assessing the success of your enterprise. How does it make money from its main business? EBITDA enters the picture here. EBITDA removes the last vestiges of financial complexity so you can concentrate on what really counts: the profitability of your company.

If this is a new idea to you, don’t worry. This blog will assist in breaking things down in detail. The subject of our discussion will be EBITDA, earnings before interest, taxes, depreciation, and amortization. To aid in your understanding of EBITDA and the calculations for this figure, examples and practical applications will be provided.

EBITDA: What is it?

EBITDA (earnings before interest, taxes, depreciation & amortization) shows how much cash a company makes on a daily basis from its regular operations. It’s not the same as net income. Taxes, financing fees, and non-cash expenses aren’t factored in. EBIDTA means focusing on operating performance rather than reported profits.

Despite its simplicity in calculations, EBITDA is not a figure recognized under GAAP (generally accepted accounting principles), but it is widely used to compare financial performance. The U.S. SEC (Securities and Exchange Commission) requires firms to reconcile EBITDA to net income because, although widely used, it is considered to exaggerate profitability.

Key Conclusions

EBITDA, or earnings before interest, taxes, depreciation, & amortization, is a metric used to assess the profitability of key businesses.
Adding interest, taxes, depreciation, and amortization costs to net income yields EBITDA.
Warren Buffett and other critics have referred to EBITDA as worthless, as it ignores capital expenses and depreciation.
According to the U.S. Securities and Exchange Commission (SEC), listed firms are prohibited from declaring EBITDA per share and must reconcile any EBITDA values they release with net income.

Calculations and Formulas for EBITDA

EBIDTA means more than just a financial acronym. It reflects operating efficiency. It is simple to compute EBITDA from the financial statements of a business, even if it isn’t reported. Calculations can be simplified with the use of tools such as Excel.

The income statement contains the net income (earnings), tax, and interest statistics, but the statement of cash flows or notes relating to operating profit typically contain the depreciation & amortization figures.

Essentially, the two EBITDA methods (operational income & net income) will provide the same outcome. (Net income is calculated by subtracting non-operating costs like interest and taxes from operational income.)

EBITDA can be calculated in two common ways:

From net income:

EBITDA is equal to = Net Income + Taxes + Interest Expenses + Depreciation & Amortization

From operating income:

EBITDA is equal to = Operating Income + Depreciation & Amortization

Depreciation & Amortization relate to asset wear & intangible write-offs.

What Is EBITDA Really Telling You?

Regardless of the financing options or depreciation assumptions employed, EBITDA, which is calculated by incorporating interest, taxes, depreciation, and amortization into net income, can be used to monitor and analyze the fundamental profitability of businesses.

Like profits, EBITDA is used in valuation ratios, most notably when combined with enterprise valuation to create the enterprise multiple, or EV/EBITDA.

The examination of sectors that are asset-intensive with large amounts of land, machinery, and other assets and associated significant non-cash depreciation expenses often employs EBITDA. In some sectors, such as energy pipelines, the expenditures that EBITDA doesn’t include could mask shifts in the actual profitability. EBIDTA means comparability across companies and industries.

The cost of developing software or additional forms of intellectual property can often be expensed through amortization. For this reason, early-stage research and technology firms may utilize EBITDA to describe their performance.

Operational performance might have little to do with yearly changes in assets and tax liabilities that need to be shown on the statement. Interest rates, the amount of debt, and leadership’s preferences for debt vs equity financing all impact interest costs. By leaving out all of these things, the emphasis remains on the company’s financial gains.

Not everybody agrees, of course. Warren Buffett, CEO of Berkshire Hathaway Inc., has said, “Allusions to EBITDA give us shivers.” Buffett asserts that EBITDA is not “a valid measure of success” and that depreciation is an actual expense that cannot be disregarded.

EBITDA Example

A business makes $100 million. Its cost of goods sold (COGS) is $40 million. Its overhead is $20 million. $30 million is the operational profit after amortization & depreciation costs of $10 million.

With a $5 million interest expense, $25 million is left over after taxes. When taxes of $5 million are deducted from the pretax income, the net income, at the 20 percent tax rate, is $20 million. EBITDA is $40 million when net income is recalculated to include depreciation, amortization, interest, and taxes.

EBITDA’s History

One of the handful of investors with a track record as impressive as Buffett’s, Liberty Media Chair John Malone, is credited with creating EBITDA. In the 1970s, the founding father of the cable industry developed the statistic to persuade lenders and investors to support his leveraged expansion plan, which involved using debt and reinvesting profits to save taxes.

Lenders and investors engaged in leveraged buyouts in the 1980s found EBITDA to be helpful in determining whether the target businesses were profitable enough to pay off the debt anticipated to be spent during the acquisition. It made it appropriate to deduct interest and tax expenses from earnings because a takeover would probably include an alteration in the capital composition and tax obligations. Depreciation and amortization expenses are non-cash charges; they won’t have an immediate impact on the company’s capacity to pay down that debt.

Because they needed to secure funding for the deals, the LBO purchasers tended to go after companies with modest or no short-term capital spending plans. They also focused on their EBITDA-to-interest ratio, which compares debt service costs to core profitability of operations as measured by EBITDA.

During the dotcom boom, EBITDA became well-known because some businesses inflated their financial results using it.

With the filing of a document for its IPO (initial public offering) by shared office space provider WeWork Companies Inc., which defined its “Community Adjusted EBITDA” as omitting general & administrative costs in addition to sales and marketing expenditures, the measure gained even more negative headlines in 2018.

EBITDA Criticisms

The method used to compute EBITDA can differ from company to company because it constitutes a non-GAAP metric. Companies often choose EBITDA over net income because it gives them a more favorable appearance.

A significant warning sign for creditors is when a business that has never before disclosed EBITDA begins to highlight it in its financial statements. Businesses that have taken on a lot of debt or deal with growing capital and development expenses may experience this. EBITDA can be used in those situations to divert investors’ attention from the difficulties facing the business.

EBITDA is also criticized for the following reasons:

1. EBITDA Does Not Consider Asset Costs

EBITDA is sometimes mistaken for cash earnings. EBITDA, however, does not account for the cost of assets, in comparison to free cash flow. It is sometimes denounced for assuming that profitability is only determined by revenue and operations, as if the business’s debt financing & assets were a gift. Buffett once again asked, “Does management assume the tooth fairy compensates for capital expenses?”

2. Suspicious Earnings Figures

Even though the procedures for figuring out EBITDA can appear straightforward, different businesses start with different earnings data. Put differently, EBITDA is vulnerable to the income statement’s earnings accounting tricks.

3. Company Worth Can Be Ignored

EBITDA’s numerous expense exclusions can give the impression that a business is far less costly than it actually is. Lower multiples are produced by analysts who focus on EBITDA stock price value multiples instead of bottom-line earnings.

Think about Sprint Nextel, a wireless telecom operator from the past. The stock price on 1^st April 2006 was 7.3 times its projected EBITDA. Even though that might seem like a low number, the company wasn’t really a good deal. Sprint Nextel traded at a significantly higher (20 times) multiple of projected operational profits.

Hedge investment strategist Daniel Loeb stated in 2015, “This shift toward utilizing adjusted EBITDA & adjusted income has produced certain firms that I think are trading on values that are not justified by the real statistics. There has been some genuine sloppiness in accounting.”

Comparing EBITDA, EBIT, and EBT

EBIT, or earnings before interest and taxes, is the sum of a business’s net income plus interest & income tax costs. EBIT is utilized to evaluate how profitable a business’s key activities are.

Earnings before tax (EBT) show the amount of operational profit before taxes are deducted, whereas EBIT does not include taxes or interest. EBT is computed by taking the net income of the business and adding merely the tax expense.

After removing a factor that is normally out of the company’s control, investors may utilize EBT to assess performance by removing tax liabilities. Comparing businesses in the US, which may be impacted by various state tax rates and federal tax laws, is where this is most helpful.

The non-cash costs of amortization and depreciation are included in EBT and EBIT, in contrast to EBITDA.

How Is EBITDA Calculated?

The equation for figuring out EBITDA is EBITDA Equals Operating Income + Amortization + Depreciation. This number appears on a company’s balance sheet, cash flow report, and income statement. EBIDTA means earnings from day-to-day operations.

How Does a Good EBITDA Look?

An EBITDA that is at least double the business’s interest expense is regarded as robust. A good EBITDA ought to be no less than $2 million, for instance, if a company’s yearly interest cost is $1 million.

An EBITDA margin of 15% may be regarded favorably in some businesses. A decent EBITDA differs depending on the industry, financial structure, growth stage, firm size, and industry standards. EBIDTA means performance before leverage and tax strategy.

What Makes EBITDA Different From EBITA?

Earnings before taxes, interest, & amortization (EBITA) is a non-GAAP financial metric that investors use to gauge a company’s profitability. EBITDA includes depreciation in the computation. EBITA is less frequently used.

EBITDA can give a better indication of operating profit in asset-heavy industries (manufacturing, utilities, telecom). EBITA could be more useful for companies that have minimal capital expenditures.

Are EBITDA & Gross Profit the Same?

EBITDA & gross profit are not interchangeable. Gross profit and EBITDA are different financial measures, despite their relationship. Before other expenses are subtracted, the profitability of basic business operations is indicated by gross profit, which is calculated as revenue less cost of goods sold (COGS). By removing taxes, depreciation, amortization, and interest, EBITDA, on the other hand, provides a more transparent picture of operational viability by removing non-operating costs and non-cash elements.

What Is EBITDA Amortization?

Amortization is the process of gradually discounting the book value of an organization’s intangible assets in relation to EBITDA. The income statement of a business includes amortization. Goodwill and intellectual property (patents and trademarks) are examples of intangible assets.

Conclusion

EBIDTA means understanding business strength. EBITDA may serve as a helpful metric for comparing businesses with different capital costs and tax treatment, or for evaluating them in scenarios where these factors are likely to alter. Non-cash depreciation expenses are also left out, which might not fairly reflect the need for future capital expenditures.

At the same time, dishonest corporate managers have been able to misuse EBITDA by omitting some costs and including others. Investors should examine the fine print when comparing stated EBITDA to net income as the best safeguard against such activities.

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What Does EBITDA Mean?

Introduction

EBITDA: What is it?

Calculations and Formulas for EBITDA

What Is EBITDA Really Telling You?

EBITDA Example

EBITDA’s History

EBITDA Criticisms

Comparing EBITDA, EBIT, and EBT

How Is EBITDA Calculated?

How Does a Good EBITDA Look?

What Makes EBITDA Different From EBITA?

Are EBITDA & Gross Profit the Same?

What Is EBITDA Amortization?

Conclusion

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