What is EBITDA?
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.
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
|Rent & Utilities||-100,000.00|
|Operating Profit (EBIT)||750,000.00|
|Earnings Before Taxes (EBT)||700,000.00|
*Income Statement for the Year Ending December 31, 2015
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
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).
- 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.
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