What is EBITDA?

Is EBITDA profit?

EBITDA is sometimes mistaken for net income or operating profit, but it differs from both. Instead, it focuses on the company’s underlying profitability from operations. While net income is the profit after all expenses, including interest and taxes, EBITDA gives you a more focused view of earnings by removing these variables. It reflects a company’s operating performance without the impact of financing and accounting decisions, so you get a clearer picture of how well the business generates earnings from its operations.

Why calculate EBITDA?

Calculating EBITDA helps you understand the cash earnings potential of a business. This is especially important for investors and creditors who want to know how much cash flows a company can generate to cover debt obligations and capital expenditures. By using EBITDA, companies can show their operating income without being affected by differences in capital structure or tax rates, so it’s easier to compare financial performance across different companies.

How to calculate EBITDA

EBITDA can be calculated in two common ways, depending on whether you start from net income or operating income:

• From Net Income: EBITDA = Net Income + Interest + Taxes + Depreciation & Amortization
• From Operating Income: EBITDA = EBIT + Depreciation & Amortization

The second approach is preferred for comparing operating performance across companies, as it avoids non-operating income and one-time adjustments.

EBITDA vs Operating Cash Flow

While both EBITDA and operating cash flow focus on a company’s ability to generate cash, they’re not the same. Operating cash flow is derived from the cash flow statement and considers changes in working capital, so it gives a more accurate picture of cash generated from daily operations. EBITDA, on the other hand, is more focused on earnings before considering non-cash expenses and financing decisions. It’s a proxy for cash flows but doesn’t capture the whole picture like operating cash flow does, such as capital expenditures or changes in working capital.

What is Adjusted EBITDA?

Adjusted EBITDA adjusts the standard EBITDA calculation to account for one-time, non-recurring expenses or revenues that are not part of the company’s regular operations. For example, a company might exclude restructuring costs or gains from the sale of assets to give a clearer picture of its core operating profitability. Adjusted EBITDA can give you a more accurate view of the company’s ongoing performance, especially when comparing companies or evaluating a business’s performance over time.

While useful for comparison, Adjusted EBITDA can be manipulated if companies exclude recurring costs (e.g., stock-based compensation). Investors should scrutinize Adjusted EBITDA adjustments to ensure they reflect true non-recurring items

When to use EBITDA over other financial metrics?

EBITDA is most useful when comparing companies within the same industry that have different capital structures or are subject to varying tax rates. It’s also a valuable metric for evaluating the value of businesses with significant non-cash expenses, such as those in industries with high levels of depreciation and amortization. But don’t use it instead of metrics like net income, operating cash flow, or gross profit entirely, as each gives you unique insights into different aspects of a company’s financials.

What are the limitations of using EBITDA?

While EBITDA is a helpful tool for evaluating a company’s operating profitability, it has some limitations:

• Ignores capital expenditures: EBITDA doesn’t account for capital expenditures, which can be significant for businesses that need ongoing investment in assets like machinery or property.
• Non-GAAP metric: EBITDA is not recognized under generally accepted accounting principles (GAAP), so it can be manipulated to present a more favorable view of a company’s financial performance.
• Excludes interest and taxes: By ignoring interest and taxes, EBITDA doesn’t reflect a company’s debt financing costs or the impact of its tax obligations on net profit. These limitations mean that while EBITDA is a useful metric, use it alongside other financial measures for a complete view of a company’s financial health.

For a comprehensive financial analysis, EBITDA should be used alongside metrics like Free Cash Flow (FCF), Net Income, and Operating Cash Flow (OCF).

How does EBITDA affect business valuation?

EBITDA plays a key role in business valuation, especially through the EBITDA multiple, which helps determine a company’s enterprise value The EBITDA multiple (EV/EBITDA) compares a company’s enterprise value (EV) to its EBITDA, helping investors assess valuation relative to earnings potential. EV includes market capitalization, debt, and cash, providing a broader valuation measure than price-to-earnings (P/E) ratios. Since EBITDA multiples differ across industries, comparisons should be made within the same sector for meaningful insights. Can EBITDA be negative?

Yes, EBITDA can be negative if a company’s operating expenses exceed its revenues before considering interest, taxes, depreciation, and amortization. A negative EBITDA means the company is struggling operationally and might not be generating enough revenue to cover its core business expenses. This is a red flag for investors, as it means the company might not be able to sustain its operations without additional financing or restructuring.

Conclusion: Using EBITDA to assess financial health

EBITDA is a versatile metric that gives you insight into a company’s operating performance, underlying profitability, and cash flow potential. While it has its limitations and shouldn’t be used instead of net income and cash flow, it’s a popular choice for investors and analysts. Understanding how to calculate EBITDA, adjusted EBITDA, and its impact on business valuation can help you get a clearer picture of a company’s financial health, so you can make better investment and business decisions.

EBITDA FAQs

What does EBITDA stand for?

EBITDA stands for Earnings Before Interest, Taxes, Depreciation, and Amortization.

Is a 20% EBITDA good?

A 'good' EBITDA margin is industry-specific but an EBITDA margin over 10% is generally seen as positive.

What is EBITDA margin?

Generally speaking, an EBITDA margin is what percentage of a dollar of revenue remains after a payment for operations charges, if any, excluding cash and finance charges. The metric combines the EBITDA of a given company with its revenues. In the context of analyzing profitability based on EBITDA, the EBITDA margin can be used to compare the performance of different firms in different sectors. Higher EBITDA margins indicate that the company is more efficient and profitable, whereas lower EBITDA margins mean the company is less efficient and profitable. A formula to calculate an EBITDA margin can be found as follows: EBITDA Margin = EBITDA / Revenue = EBIDTA / Revenue.

This material is for informational purposes only and should not be considered as an investment recommendation or a personal recommendation.