EBITDA stands for earnings before interest, taxes, depreciation, and amortization. EBITDA is an indicator of a company's financial performance and is used as a proxy for a business's profit potential, although doing so has its drawbacks. Additionally, EBITDA strips the cost of debt equity and its tax effects by adding interest and income taxes.
EBITDA - Results Before Interest, Taxes, Depreciation and Amortization.
In its simplest form, EBITDA is calculated as follows:
EBITDA = Operating Income + Depreciation Expense + Amortization Expense
The most literal formula for EBITDA is:
EBITDA = Net Income + Interest + Taxes + Depreciation + Amortization
EBITDA is essentially net income with interest, taxes, depreciation and amortization added back to it. EBITDA can be used to analyze and compare profitability across companies and industries, as it eliminates the effects of financial and accounting decisions. EBITDA is often used in valuation ratios and is compared to the value of the company and revenue.
EBITDA example:
A retail business generates $ 100 million in revenue and incurs $ 40 million in product costs and $ 20 million in operating expenses. The depreciation and amortization expense amounts to $ 10 million, resulting in an operating profit of $ 30 million. Interest expense is $ 5 million, leading to pre-tax earnings of $ 25 million. With a 20% tax rate, net income equals $ 20 million after taxes of $ 5 million is subtracted from pre-tax income. Using the EBITDA formula, we add the operating profit to the depreciation and amortization expense to obtain an EBITDA of $ 40 million ($ 30 million + $ 10 million).
EBITDA is a non-GAAP measure that allows greater discretion as to what is and what is not included in the calculation. This also means that companies often change the items included in their EBITDA calculation from one reporting period to the next.
EBITDA first came into common use with leveraged purchases in the 1980s, when it was used to indicate a company's ability to pay debt. As time passed, it became popular in industries with expensive assets that had to be written down over long periods of time. EBITDA is now commonly quoted by many companies, especially in the technology sector - even when it is not guaranteed.
