Introduction
EBITDA, short for Earnings Before Interest, Taxes, Depreciation, and Amortization, is an indicator of the financial performance of a company. It is an alternative to the traditional measures of a company’s performance, such as operating profits. Similarly, it is also considered an alternative for the operational cash flows of a company. EBITDA is one of the many variations of the EBIT metric.
Importance of EBITDA
EBITDA is a crucial metric for investors and businesses. The metric gives investors a quick estimate of the value of a specific company. Besides, companies that suffer in converting revenues into profits can still have a positive EBITDA. That is because EBITDA considers the earnings of a company before considering items that are outside its control. Therefore, investors can use EBITDA to determine whether the losses made by a company related to operating deficiencies or other factors.
Similarly, EBITDA is also vital because it allows investors to compare between different companies in a better way. However, they can only use it to compare similar companies operating in the same industry. Furthermore, it can also allow companies to compare their performance against competitors and other similar companies to identify any problems within their processes.
Problems with EBITDA
Using EBITDA can also have some problems. Firstly, EBITDA is not an officially recognized metric by any accounting standard. Similarly, some experts believe that taking out depreciation from EBITDA disregards the lost value of assets over time. Therefore, it can produce inaccurate results, especially for companies that acquire many assets over time through the use of debt instruments.
How to calculate EBITDA?
The calculation of EBITDA is straightforward. The formula to calculate EBITDA is below.
EBITDA = Earnings + Interest + Taxes + Depreciation + Amortization
The figures required in calculating EBITDA are available in the financial statements of a company. The earnings, interest, and tax amounts are available in the Statement of Profit or Loss of companies. The figures for depreciation and amortization are obtainable from the Notes to the Financial Statements.
There’s also an alternative formula to calculate EBITDA, given below.
EBITDA = Operating profit + Depreciation + Amortization
The operating profit of a company is its profit before interest and taxes, also referred to as EBIT, available in its Statement of Profit or Loss.
Example
A company has earnings of $100 million. It charged interest expense of $7 million, taxes amounting to $3 million, depreciation of $10 million, and amortization of $5 million in its financial statements. To calculate its EBITDA, the company can use the following formula.
EBITDA = Earnings + Interest + Taxes + Depreciation + Amortization
EBITDA = $100 million + $7 million + $3 million + $10 million + $5 million
EBITDA = $125 million
Conclusion
EBITDA is a metric widely used as an indicator of the financial performance of a company. EBITDA stands for Earnings Before Interest, Taxes, Depreciation, and Amortization. There are many different uses of EBITDA, although it may come with some problems. There are two formulas used in the calculation of the EBITDA of a company.
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