EBITDA, or earnings before interest, taxes, depreciation, and amortisation, is a financial performance indicator that can be used instead of net income in some situations. EBITDA, on the other hand, might be deceiving because it excludes the cost of capital investments such as property, facilities, and equipment.
By adding back interest expenditure and taxes to earnings, this statistic also removes debt-related expenses. Nonetheless, because it can reflect earnings before accounting and financial deductions, it is a more precise indicator of business performance.
Simply explained, EBITDA is a profitability metric. While there is no legal necessity for corporations to publish their EBITDA, it can be calculated and reported using information from their financial statements, according to US generally accepted accounting principles (GAAP).
The income statement includes figures for earnings, taxes, and interest, whereas depreciation and amortisation are usually included in the notes to operating profit or on the cash flow statement. Starting with operating profit, also known as earnings before interest and tax (EBIT), and adding back depreciation and amortisation is a common shortcut for computing EBITDA.
EBITDA Calculation and Formula
EBITDA is calculated in a straightforward manner, using data from the income statement and balance sheet of a corporation. EBITDA is calculated using two formulas: one that utilises operating income and the other that uses net income.
EBITDA = Net Income + Taxes + Interest Expense + Depreciation & Amortisation
and
EBITDA = Operating Income + Depreciation & Amortisation are the two EBITDA computations.
Understanding EBITDA
EBITDA is net income (or earnings) adjusted for interest, taxes, depreciation, and amortisation. Because it excludes the effects of finance and capital expenditures, EBITDA may be used to examine and compare profitability across organisations and industries. EBITDA is frequently used in valuation ratios and can be compared to sales and enterprise value.
Interest expenses and (to a lesser extent) interest income are added back to net income, thereby neutralising the cost of debt as well as the tax impact of interest payments. If the company suffers a net loss, income taxes are also added back to net income, which does not always boost EBITDA. When a company's net income isn't particularly outstanding (or even positive), it tends to focus on its EBITDA performance.
Depreciation and amortisation accounts are used by businesses to deduct the cost of property, plants, and equipment, as well as capital investments. Amortisation is a method of accounting for the costs of software development and other intellectual property. One of the reasons why EBITDA is used by early-stage technology and research companies when talking with investors and analysts is because of this.
When capital expense categories are eliminated, management teams will claim that EBITDA provides a better picture of profit growth trends. While using EBITDA as a growth statistic isn't necessarily deceptive, it can occasionally obscure a company's actual financial performance and dangers.
Why use EBITDA?
EBITDA is a popular statistic for estimating cash flow. By multiplying it by a valuation multiple collected from equity research reports, industry transactions, or M&A, it can give an analyst a rapid estimate of the company's value as well as a valuation range.
Furthermore, investors can use EBITDA to assess a company while it is not profitable. This statistic is popular among private equity firms since it allows them to compare companies in the same industry. It is used by business owners to evaluate their own performance in comparison to that of their competitors.
What are the drawbacks of EBITDA?
The following are some of EBITDA's disadvantages:
- Because debt expenses are not included in EBITDA, the resulting statistic is considered deceptive. It does not reveal the actual earnings or liquid assets of a corporation.
- Many business owners use it to conceal their bad financial judgement and financial flaws.
- It has no effect on high-interest credit card debt.
- When evaluating a company's financial performance, it does not account for depreciation and EBITDA amortisation as genuine expenses.
- Companies must employ additional financial parameters in addition to EBITDA to arrive at a more accurate valuation.
As a result, EBITDA is a good approach to measure a company's core profit trends because it includes non-core components. However, both investors and business owners must employ other, more thorough financial criteria to arrive at a more comprehensive financial analysis.
