The basics of EBITDA

Category: Financial.

When you want to understand how a certain company thrives in a particular industry, you need to have certain formulas in mind. An acronym for Earnings before Interest, Taxes, Depreciation, and Amortization, EBITA is very useful when it comes to understanding a company’s ability to generate profit. This will help you see its operating performance in comparison to other similar companies.

By adding all the expenses back into the net income, accountants are able to truly see the operating cash flow of the business. Using it along with EBIT and EBITA, you will get a good picture of what needs to be improved for the cash flow.

The EBITDA Formula

To get the result for EBITDA, you need to take your net income and subtracting everything else except the taxes, interest, amortization, and interest. As a result, the formula will be this:

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

Sometimes, this equation is calculated by taking the earnings (EB) and adding the rest of the costs (ITDA). An investor can also see the way in which the company is affected by debt – but without the distraction brought by the depreciation. As a result, the formula can be changed as to only include net income, interest, and amortization.

Understanding the Formula

To understand the formula for EBITDA, you first need to understand the components.

  • Earnings:The name may be “earnings,” but this actually refers to the net income of the company. This is practically the core profit that the company registers at the income statement’s bottom end.
  • Taxes:Depending on the line of business, these taxes can change every year. The things that can change their value are the company location, size, and industry. You can generally find the taxes in the income statement, in the section for non-operating expenses.
  • Interest: Interest expenses can also vary depending on the company. Generally, the bigger the company, the higher the expense will be. You can also find this number in the non-operating cost section of your income statement.
  • Depreciation and Amortization:Unlike the previous components, these two are found in the operating expenses category – but still part of your income statement. These will register the costs called by a capital asset during the time that it was used.

Analyzing EBITDA

To put it as plainly as possible, EBITDA measures the profitability of a company before it is required to pay government taxes, interest to the creditors, and expenses such as amortization and depreciation. What you have to understand is that this is not a financial ratio. Instead, it’s a probability calculation that uses monetary measurements instead of percentage.

Like with other measurements, the higher the resulted number, the more attractive it will seem for investors. A high number is a clear picture of its profitability. If the number is high, this means that the company will have more money left after all the other expenses have been paid. However, to see the true profit of a company, you might want to use it together with EBIT and EBITA.

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