EBITDA stands for
E – Earnings
B – Before
I – Interest
T – Taxes
D – Depreciation
A – Amortization
In simple words EBITDA is financial metric which shows how much company earns before non-operational expenses like Interest and taxes and cash expenses like depreciation and amortization. EBITDA measures the company’s overall ability to generate cash by not taking account that how much cash will be spent on essential expenses. Though company is financed by debt, equity, cash or combination of any two or all of these EBITDA remains same it’s not affected.
Most companies did not disclose EBITDA but in some case investor may want to know this to observe the potential of the company. In some case company representative manipulates it to show better cash flow of company. Business that are financed by huge debt can report high EBITDA but after interest payment the net margin of these companies goes below the standards.
To compare two similar companies EBITDA is useful. It is expected that similar group industry can pay same taxes, same depreciation and amortization on assets.
Why EBITDA is important for Business?
EBITDA is important for business owners as it shows the company’s true value and secondly it shows the company’s worth to investors.
It analyzes company’s profitability among competitor companies by providing raw indication of earnings.
How to calculate EBITDA?
EBITDA is earning with interest, taxes, depreciation & amortization added back. In simple way we can formulate the EBITDA as below,
EBITDA = Operating Income + Depreciation & Amortization
Or
EBITDA = Net Income + Taxes + Interest + Depreciation & Amortization
Or
EBITDA = Revenue – Cost of Goods Sold – Salaries & rent
EBITDA Vs Net Income
EBITDA calculates the profit of the company before paying expenses, taxes, depreciation, and amortization while NET INCOME is profit of the company after paying expenses, taxes, depreciation, and amortization. In short net income can be formulated as
Net Income = Revenue – Cost of doing Business
EBITDA is calculated to check earning potential of the company while net income shows income per share. Mostly EBITDA is used for early stage companies like startups to see how they perform while net income is used in all circumstances to check the financial health of the company.