EBTIDA10 Nov 2018 20:56
EBITDA - Earnings Before Interest, Taxes, Depreciation and Amortization
What is 'EBITDA - Earnings Before Interest, Taxes, Depreciation and Amortization'
EBITDA stands for earnings before interest, taxes, depreciation and amortization. EBITDA is one indicator of a company's financial performance and is used as a proxy for the earning potential of a business, although doing so can have drawbacks. EBITDA strips out the cost of debt capital and its tax effects by adding back interest and taxes to earnings.
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BREAKING DOWN 'EBITDA - Earnings Before Interest, Taxes, Depreciation and Amortization'
EBITDA is essentially net income with interest, taxes, depreciation and amortization added back to it. EBITDA can be used to analyze and compare profitability among companies and industries as it eliminates the effects of financing and accounting decisions. EBITDA is often used in valuation ratios and compared to enterprise value and revenue.
In its simplest form, EBITDA is calculated in the following manner:
EBITDA = Operating Profit + Depreciation Expense + Amortization Expense
The more literal formula for EBITDA is:
EBITDA = Net Profit + Interest +Taxes + Depreciation + Amortization
If you're interested in learning how to calculate EBITDA using MS Excel we've got it covered.
Breaking Down EBITDA
Let’s take a look at the key factors that make up EBITDA. Interest is any income a business earns from its various investments. Taxes are, obviously, any of the obligations owed by the company to the Internal Revenue Service (IRS). Depreciation and amortization both reduce the costs of assets held by the business over time.
By taking these out of the equation, EBITDA gives investors a good idea of how a company is doing financially and paints a portrait of how much cash a young or restructured company may generate before paying its debts. Using EBITDA as a metric also means it shows higher profits rather than simply providing operating profits. This is especially important for companies that are more focused on capital such as cable and telecoms.
Example of EBITDA
A retail company generates $100 million in revenue and incurs $40 million in product cost and $20 million in operating expenses. Depreciation and amortization expense amounts to $10 million, yielding an operating profit of $30 million. The interest expense is $5 million, leading to earnings before taxes of $25 million. With a 20 percent tax rate, net income equals $20 million after $5 million in taxes are subtracted from pre-tax income. Using the EBITDA formula, we add operating profit to depreciation and amortization expense to get EBITDA of $40 million ($30 million + $10 million).
The Drawbacks of EBITDA
EBITDA is a non-GAAP measure that allows for a greater amount of discretion in what i
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