EBITDA

Smoke and Mirrors

What is EBITDA?

Earnings
Before
Interest
Taxes
Depreciation
Amortization

EBITDA shows a company’s financial performance and is calculated through the following equation:

EBITDA = (Earnings Before Interest and Taxes or EBIT) + Depreciation + Amortization

It is often used by investors to value companies that are not making a profit.


Podcast: Adjusted EBITDA


Why is it Important?

EBITDA gives investors a reference point for a company’s profitability. It also provides a way to compare many companies without having to worry about company-specific additions and deductions.

EBITDA from an Income Statement



To calculate EBITDA from this income statement, we find EBIT ($750,000), depreciation ($50,000), and amortization ($0). EBITDA = $750,000 + $50,000 + $0 = $800,000.

EBITDA can also be calculated through this equation:

EBITDA = Net Profit + Interest + Taxes + Depreciation + Amortization

EBITDA Margin

The EBITDA margin shows how operating expenses affect a company’s profit—the higher the margin, the less risky the company is financially.

EBITDA Margin = EBITDA ÷ Total Revenue

  • Industries with the highest EBITDA margins include banks, oil and gas production and exploration, utilities, railroads, power, mining, telecom, semiconductor manufacturers, tobacco, and alcoholic beverages.
  • Industries with the lowest EBITDA margins include gasoline stations, auto dealerships, petroleum products and wholesalers, furniture stores, grocery stores, music stores, and liquor stores.

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Problems with EBITDA

EBITDA can also be misleading. By adding back depreciation and amortization, a company’s profits may seem greater than they actually are. Also, since a company’s liquidity changes due to interest, taxes, and expenditures, a positive EBITDA won’t always mean a healthy company because taxes and interest are actual expenses that business have to account for.

EBITDA is sometimes seen as an accounting trick to make a company appear that it is earning more money than it really is (since it essentially ignores the interest, taxes, depreciation, and amortization the company must pay).

Fun Facts:

  • With so many companies using EBITDA to inflate their revenue, Chris Edmonds of TheStreet.com, suggests that EBITDA really stands for Earnings Before I Trick Dumb Auditors.

References

  1. http://www.investopedia.com/terms/e/ebitda.asp#
  2. http://d2dp98nruyknlg.cloudfront.net/cdn/farfuture/XqnQFGNzKqfpxKlt0OgOhXAwtnqTvd7oKVrQUjX0Pt8/mtime:1383137197/images/ebitda.gif (image)
  3. http://www.businessnewsdaily.com/4461-ebitda-formula-definition.html
  4. http://www.investinganswers.com/financial-dictionary/financial-statement-analysis/earnings-interest-tax-depreciation-and-amortizatio
  5. http://www.bankrate.com/finance/investing/how-to-calculate-ebitda.aspx
  6. http://www.investopedia.com/ask/answers/052015/which-industries-tend-have-greatest-ebitda-margins.asp
  7. http://www.forbes.com/sites/sageworks/2011/08/26/who-has-the-lowest-ebitda-margins/#28b5b3886276
  8. http://www.slate.com/articles/business/moneybox/2002/06/the_accounting_trick_thats_killing_worldcom.html

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