What is EBITDA and how to calculate?

EBITDA is a financial metric that provides insights into the prof­it­ab­il­ity of various business activ­it­ies. It is par­tic­u­larly useful for comparing different companies.

What is EBITDA?

EBITDA is an acronym that stands for ‘earnings before interest, tax, de­pre­ci­ation, and amort­isa­tion’. As an economic key figure, EBITDA therefore solely rep­res­ents the result of the company activ­it­ies, with interest costs and interest earned as well as all de­pre­ci­ation being excluded.

EBITDA plays a crucial role in both a company’s taxation and its eval­u­ation by external or­gan­isa­tions. It gives in­form­a­tion about the prof­it­ab­il­ity of company activ­it­ies, and for this reason it is also used to evaluate how cred­it­worthy companies are. Some companies even deploy this key figure to determine manager salaries. The value gives a good im­pres­sion of the prof­it­ab­il­ity of company activ­it­ies and leaves out those items that do not have anything to do with it. This includes:

• Interest costs and earnings: Loan interest and earnings from shares are dependent on the financial strategy of a company and do not directly have to do with its activ­it­ies.
• Taxes: The taxes due depend on many different, often also ex­traneous factors, and do not say anything about the prof­it­ab­il­ity of company processes.
• De­pre­ci­ation: De­pre­ci­ation on tangible assets and im­ma­ter­i­al goods is the result of in­vest­ments that a company wants to or has to make. They are therefore not mean­ing­ful when it comes to company processes in the strict sense.

EBITDA is therefore an in­dic­a­tion of the status of sales within a company. As de­pre­ci­ation is not included, the key figure does not give any in­form­a­tion about the success of a company overall.

In addition to the ‘pure’ EBITDA described above, the term adjusted EBITDA is also commonly used. This metric excludes ex­traordin­ary costs and income from the company’s results but retains expenses closely tied to business op­er­a­tions—such as de­pre­ci­ation on assets used for these activ­it­ies. However, there is no precise defin­i­tion of what con­sti­tutes ex­traordin­ary costs and income. As a result, the re­li­ab­il­ity of this metric when comparing different companies is also limited.

Dif­fer­ence between EBITDA and EBIT

In addition to EBITDA, another key metric that may be of interest to you is EBIT (Earnings Before Interest and Taxes). Unlike EBITDA, EBIT focuses solely on profit before interest and taxes, without factoring in de­pre­ci­ation and amort­isa­tion. The term ‘Operating Income’ is often used in­ter­change­ably with EBIT.

How to calculate EBITDA

EBITDA is best cal­cu­lated starting from net income (a value that can be found in the income statement, which is commonly used by busi­nesses and required for publicly traded companies under GAAP. Net income refers to profit after taxes. This means that all items not included in EBITDA are added back or excluded as follows:

You therefore add on ex­pendit­ure on taxes and interest as well as de­pre­ci­ation, or you deduct the relevant revenues from the result.

The EBITDA margin can ul­ti­mately also be cal­cu­lated from EBITDA. It rep­res­ents the re­la­tion­ship between EBITDA and sales.

EBITDA explained in two examples

We have chosen two fic­ti­tious companies for our example. Each has an annual net profit of £1 million. However, as both companies have their head offices in different countries and also pursue differing financial and in­vest­ment strategies, there is also a variance between their EBITDA values.

Company 1:

Because there were no earnings in the tax, interest and de­pre­ci­ation items, these factors must be added in full for the EBITDA cal­cu­la­tion. Finally, an ex­traordin­ary return is deducted for the cleaned EBITDA, which has a positive effect on the annual net profit. The second company has generated the same annual net profit, but is pursuing a com­pletely different financial and in­vest­ment strategy; it also has its head office in a different country with lower tax on profits.

As the second company has to pay less in taxes on the same annual net profit and also records lower costs on interest and de­pre­ci­ation, EBITDA comes out a little lower than for the first company. One would therefore attribute a lower success level in the business op­er­a­tions to the second company. For the second company the ‘adjusted’ EBITDA also cor­res­ponds to the uncleaned one, as it did not register either ex­traordin­ary revenues or ex­traordin­ary expenses in the financial year.

Please note the legal dis­claim­er for this article.