How to Calculate EBITDA

In this article, we will learn about the components of EBITDA, the formula used to calculate it, and the limitations it faces.

Definition of EBITDA

EBITDA stands for “Earnings Before Interest, Taxes, Depreciation, and Amortization,” and it is a calculation used to determine a company’s income from business operations by separating this income from non-operational variables. To understand this measure better, it is important to take a closer look at each component of the acronym.

Operating Income

Operating income is the same as a company’s net profit or net income. It is income minus expenses and includes profits from all types of sources.

Variables in EBITDA

The four variables are typically presented in two sections on the financial statement – interest expenses and taxes, then depreciation and amortization.

Interest:

Interest expenses are considered the cost of using borrowed funds for business purposes. This can be interest on a commercial loan or business investment.

Taxes:

In the case of EBITDA, taxes include those paid by the business, including income taxes, consumption taxes, and employment taxes (social security taxes and unemployment taxes).

Depreciation and Amortization:

Depreciation and amortization are terms used to describe the process of deducting the costs of purchasing and using long-term assets that the company uses to generate profit. The company deducts these costs over a period of time, depending on the type of asset. Depreciation is used for tangible assets such as vehicles, buildings, machinery, and equipment. Amortization is used to deduct the costs of intangible assets, namely those that have no physical form, such as copyrights, trademarks, and patents.

Note:

You can find the EBITDA information for a public company by reviewing its annual shareholder report or its 10-K form, which is an annual report submitted to the Securities and Exchange Commission (SEC). You can use the SEC’s EDGAR database to find these disclosures.

How to calculate EBITDA?

Here is the formula used to calculate EBITDA:

EBITDA = Net Income + Interest Expenses + Taxes + Depreciation + Amortization = Operating Income.

The table below provides an example of calculating EBITDA:

What does EBITDA mean for individual investors?

Investors can compare EBITDA information for several companies as part of their investment analysis. This allows them to evaluate companies based solely on their operations, excluding the impact of taxes, debt amounts, and the cost of their capital investments.

It answers the question, “Which company is the best at generating income?” If investors are looking at several companies of different types, they can rank them based on EBITDA to see which company is the best at converting sales into profits.

EBITDA is one of the methods used to analyze profitability. A similar analysis is EBIT, earnings before interest and taxes.

Limitations of EBITDA

Although EBITDA can be useful in determining profitability, there are certain limitations to using this measure. For example, EBITDA does not reflect cash flow, which is another important measure for companies. Cash flow is the movement of cash into and out of the company as reported in the cash flow statement.

Also, EBITDA is not listed as a measure of net income as required in Generally Accepted Accounting Principles (GAAP). You may see “non-GAAP” in the calculation of EBITDA, meaning this term does not comply with standards.

Frequently Asked Questions

What is adjusted EBITDA? Some companies include a calculation that adjusts EBITDA for the following factors:

• Unusual costs
• Stock compensation for executives
• Debt repayment losses
• Income or loss from discontinued operations (such as closing locations)

These are special circumstances that may affect the company’s profits on a one-time basis or for a short period.

What is EBITDA margin? The margin, also known as safety margin, is used in accounting to calculate the company’s sales compared to its profit. Investors use the margin to evaluate potential investments for possible losses and determine the best price for a stock trading below its intrinsic value.

It is considered

The EBITDA margin is one of the many ways investors assess the margin of safety.

What is a good EBITDA multiple? Multiples are ratios used to compare potential investments that investors may be considering. Some typical EBITDA multiples are:

• EBITDA compared to sales
• EBITDA compared to selling, general, and administrative expenses (SG&A)
• EBITDA compared to research and development expenses (R&D)

To determine whether an EBITDA multiple is good, you should look at it compared to other similar companies. For example, the average EBITDA/sales margin for the advertising industry is 17.39%, meaning that EBITDA represents 17.39% of sales. This is a measure of profitability; if there is an EBITDA/sales multiple higher than the average, it means the company is more profitable.

Source: https://www.thebalancemoney.com/how-to-calculate-ebitda-5208417