What Is EBITDA and How to Calculate It

• EBITDA refers to a company’s earnings before interest, taxes, depreciation and amortization.
• It’s a measure of a company’s profitability that can be used in business valuation.
• There are a couple of simple ways to calculate it using basic information found in your company’s financial statements.

When it comes to corporate finances, you’ll need to understand and employ a significant number of financial tools to keep things operating smoothly. EBITDA — earnings before interest, taxes, depreciation and amortization — is perhaps one of the most common and fundamental among them. 

However, EBITDA can be a bit confusing for new business owners. This metric helps compare your business’s ability to generate money to that of your peers, which makes it essential in measuring your commercial success.

If you’re making an EBITDA calculation for the first time or want to make sure you’re covering your bases, read more to understand what it is and why it’s so important to track.

EBITDA Meaning

EBITDA is an acronym for earnings before interest, taxes, depreciation and amortization. The EBITDA formula helps define a company’s profitability. Here’s what each term means when broken down: [Note: Bold text added to the start of each bullet]

• Earnings: The money your business brings in during a certain period of time, typically measured in months or quarters.
• Interest: Money paid to lenders, in addition to a loan’s principal. This information typically can be found on an income statement.
• Taxes: Any local, state or federal taxes due as part of your business's activities
• Depreciation: Reductions in the value of existing tangible assets such as office supplies or inventory, or other capital expenditures.
• Amortization: A calculation that measures reductions in loan payment totals over time, as well as reductions in the value of intangible assets, such as proprietary software or other nonphysical goods. The latter is akin to depreciation but applied typically for nonphysical items.

EBITDA helps illuminate the effects of a company’s capital structure on its bottom line and cash flow, especially compared to those of its competitors. This calculation ignores interest, taxes, depreciation and amortization, exclusively focusing on a company’s revenue and cash flow minus its operating expenses – unlike gross profit, which only considers revenue minus cost of goods sold.

EBITDA variations

There are other versions of EBITDA, as well; some factor in fewer criteria, while others include more. Each helps you better understand different aspects of your financials or can serve as a better performance metric if it more closely aligns with your current business financial conditions. Here are a few other common EBITDA variations you might want to consider tracking:

• Adjusted EBITDA: To account for extraordinary and one-time expenses during a business valuation, valuators will often adjust the typical EBITDA to include items like nonoperating income, noncash expenses and litigation costs.
• EBT: Earnings before taxes measures a company’s operating performance before deducting income tax expenses, but after the other expenses that EBITDA ignores.
• EBIT: Earnings before interest and taxes. Unlike EBITDA, this calculation does not include the cost of depreciation and amortization from a business’s net profit. This measure of a company can help account for different interest rates businesses may pay, depending on their location, among other things.
• EBIAT: Earnings before interest after taxes. This calculation provides a simpler understanding of a business’s post-tax earnings before interest payments are factored in.
• EBITDAR: Earnings before interest, taxes, depreciation, amortization and restructuring/rent. This calculation adds to the classic EBITDA by including any costs associated with reorganizing a business or rent payments.

Why is EBITDA important?

When you use EBITDA, you’re able to look at a core business performance metric to assess how well your company is doing. Having this information is helpful if you choose at some point to seek investors for your business or secure a buyout.

Using EBITDA for business performance

Certain nonoperating expenses, like taxes, interest expenses and depreciation can vary widely between different companies, industries and tax jurisdictions that can make comparing one company to another tough.

That’s why EBITDA exists: so there’s an easy way to compare raw earnings within your own business over time, as well as to determine how you stack up alongside your industry peers.

Using EBITDA for investors and acquisitions

Lenders may consider your company’s EBITDA when vetting you as a prospective borrower, since it can also show a company’s debt service coverage ratio, or ability to repay loans, and its ability to meet other short-term obligations.

Finally, EBITDA can be used in the process of business valuation, by comparing businesses within the same industry that are similar in size and scope. By dividing a company’s enterprise value (its equity value plus its debt) by its annual EBITDA, the resulting ratio, called the EBITDA multiple, compares a business’s value to its raw earnings, which investors can use in acquisitions.

EBITDA formulas

Calculating your business’s EBITDA is usually a straightforward process, and you can typically do so with the information found on your existing financial statements – particularly your company’s income statement and balance sheet. 

There are two common formulas for calculating EBITDA, which should arrive at the same result most of the time. One begins with net income while the other begins with operating profit. Whichever formula you choose, stick with that one as you continue to calculate your business’s EBITDA over time to ensure consistency.

Although EBITDA is an important metric and may even seem somewhat intimidating, it’s truly as simple as the calculations shown above. It’s just another way of looking at your earnings before factoring in nonoperating cash outflows.

How to calculate EBITDA

Let’s use an example to put the EBITDA formulas to work.

Company A earns $1,000,000 in revenue with $300,000 in cost of goods sold and $200,000 in operating expenses. Interest expenses total $100,000, depreciation totals $40,000 and amortization expenses come out to $60,000. This leaves $300,000 in earnings before taxes. At a tax rate of 25%, or $75,000, this results in $225,000 of net income.

First, let’s calculate Company A’s EBITDA using the first formula:

Then, using the second formula:

As you can see, both formulas yield the same EBITDA of $600,000.

What’s a good EBITDA?

The idea of a “good EBITDA” depends on several factors, rather than a one-size-fits-all figure. For instance, good EBITDA can include industry benchmarks, your own business expenses and your cash flow, but a few additional factors can come into play. Overall, it’s tough to quantify what counts as a “good EBITDA” unless you know your competitors’ EBITDA as well as your own.

You can, however, evaluate your own EBITDA through what’s known as an EBITDA margin. This figure provides you with a numerical valuation expressed as a percentage that is less dependent on broader industry conditions to measure your performance. You can calculate your EBITDA margin with this formula:

For example, if your EBITDA is $400,000, and your total revenue is $4,000,000, your EBITDA margin is 10%. An EBITDA margin of 10% or more is typically considered good, as S&P 500-listed companies generally have higher EBITDA margins between 11% and 14%. You can, of course, review EBITDA statements from your competitors if they're available — whether they provide a full EBITDA figure or an EBITDA margin percentage.

Final considerations

Even though EBITDA is a straightforward metric to calculate and use as a comparison point, it’s seldom a good idea to rely on EBITDA alone to size up your business financials. Many investors are reluctant to assess a company’s financial performance solely based on EBITDA since it doesn’t take several key expenses and important factors into account, like copyrights, other intellectual property and changes in working capital. Moreover, it is not recognized by generally accepted accounting principles (GAAP).

Rather, your company’s EBITDA is but one of several metrics you should calculate to better understand your company’s financial health. To examine your business performance from alternative angles, you should also consider calculating your cash flow, operating margin and more.