Ebitda is a metric frequently used by companies to measure their operational performance, giving an accurate reflection of a company’s operating profitability when they want to put their agency up for sale. Companies can analyze their earnings without considering things like interest or taxes.
This metric is one of the many ways used to calculate a company’s profitability without the inclusion of interest, taxes, depreciation and amortization. It can be used to determine the value of a business when providing investors with an update or before a sale. With this analysis, a company can easily compare the results of its operational activities to that of its competitors and others within their industry.
The margin provides analysts and investors with a preview of short-term operational efficiency when conducting financial analysis.
In this guide, let’s look at Ebitda, Ebitda margin, why it’s important and how it’s used.
What does Ebitda stand for?
EBITDA’s acronym is broken down to earnings before interest, taxes, depreciation, and amortization. The Interest includes the expenses to a business caused by interest rates, like loans offered by a bank. Taxes include the expenses to a business caused by all tax rates within their city, state, or country.
They are determined by location and do not specify the profitability or viability of a company. Depreciation is a non-cash expense one proxy for expected capital expenditures. Amortization is a non-cash expense referring to the cost of intangible assets on the balance sheet.
The Importance of Ebitda
Many businesses and companies use Ebitda since it gives an accurate calculation of business performance and how much it can profit, without including factors such as taxes and interest which you cannot control. However, it’s just measuring profitability and not necessarily cash flow.
Ebitda calculations are quite helpful, especially for investors considering buying or investing in a business. The information gained can be used to determine how profitable and successful the business can be. However, things such as debt and depreciation are not important to a new owner or investor since they cannot be transferred from one to another.
Ebitda vs. Gross Profit
Gross profit is used to measure profitability and is the total amount of income earned before subtracting the direct cost of goods. Ebitda and gross profit assess the financial performance of a business.
However, Ebitda is used to measure a business performance minus operating expenses while gross profit determines the overall performance of the business while taking into consideration its ability to manage costs.
EBITDA, EBIT and EBIT
EBIT stands for earnings before interest and taxes and is used to see the performance of a company without factoring in taxes and interest expense thus usually associated with operating income. EBIT factors in D&A expenses are often ignored as too variable among comparable companies.
Earnings before taxes (EBT), display how state taxes or country taxes affect a company’s income. The main difference between EBIT and EBITDA is in their treatment of depreciation and amortization. EBITDA, EBT and EBIT are all similar and financial professionals learn more about a company’s profitability.
EBITDA AND EBITDA margin calculation
EBITDA calculation is quite straightforward with information from a company’s income statement and balance sheet. It’s calculated as follows:
Method 1
EBITDA = net income + taxes + interest expense + depreciation and amortization.
Defined as: D=Depreciation and A=Amortization
Method 2
EBITDA=Operating Profit + DE + AE
Defined as: DE=Depreciation expense and AE=Amortization expense
EBITDA Margin
A good EBITDA is determined by calculating the EBITDA margin. EBITDA margin metrics are related to EBITDA and view EBITDA as a percentage of total revenue. It’s calculated as:
EBITDA Margin = EBITDA / Total Revenue
The results from this calculation show the cash profit made by a business within a year and can be compared to other businesses in the same industry.
The EBITDA margin metric is very useful for businesses without a high level of debt or which don’t regularly make purchases of large fixed assets and thus depreciation plays a huge role and should be factored into most metrics. But for a company with little debt or depreciation, EBITDA margin percentages can be quite helpful.
Here are some steps you can use in EBITDA calculations
1. Complete the income statement
You will start the calculation with the net income or earnings which can be found on the income statement. The net income is calculated by subtracting all expenses from the total revenue including everything from the cost of goods sold (COGS) to the interest, operating expenses, tax payments and any other relevant costs.
To calculate EBITDA you must add back the interest and tax line items as well as the depreciation and amortization expenses. This is the net profit of the business after incorporating all incurred expenses.
2. Include interest expenses
A company’s profitability isn’t determined by assessing the interest expenses therefore, the interest has to be part of the EBITDA calculation. Interest expenses only show how well the business manages loans, which isn’t always a priority to a business owner or investor.
Interest is also taxed and ends up being less relevant. The cost of interest can be found on the income statement.
3. Add taxes
Every business needs to pay taxes but they don’t reflect the profitability of the business. Tax rates differ depending on the location or size of your business. They include personal property taxes, payroll taxes, and local taxes.
4. Add depreciation and amortization
Resources and assets like office buildings, machinery, commercial equipment and work vehicles lose value over time. Depreciation and amortization are the reductions in these values and they can be found in the company’s cash flow statement.
Some companies can have larger depreciation costs though this does not reflect their profitability. Amortization is the amount of debt a company has that does not reflect on the company’s success or profitability. It varies from one business to another depending on the value of the company’s resources or assets.
Conclusion
Ebitda can be very useful when reviewing a company’s profits. Investors and new business owners must be extra keen on valuations that rely too heavily on Ebitda. Any investors and new owners must consider the net income, financial strength and cash flow metrics of a business.
