EBITDA: What Does Your Company Earn From Its Sales? EXPLAINED

EBITDA serves as an alternate approach to assessing a company's profitability compared to its net income which assesses the operational performance of the firm

EBITDA stands as a dependable metric for business valuation, allowing buyers to focus on the fundamental profitability of the company

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Did you ever wonder to yourself what is this EBITDA that everyone keeps raving about when watching Shark Tank? The founders, sharks all seem to revolve their judgement around this number, but exactly what is it? Let's try to understand this metric that helps a company understand how well it is converting its sales into profits before taking into account other factors.

What Is EBITDA?

EBITDA stands for earnings before interest, taxes, depreciation, and amortisation. It serves as an alternate approach to assessing a company's profitability compared to its net income. This metric is employed to assess the operational performance of a company, excluding tax obligations and the influence of capital structure expenses on earnings or profits.

It is not a metric recognised under generally accepted accounting principles (GAAP). Some public companies include EBITDA in their quarterly reports, often alongside adjusted EBITDA figures, which typically exclude extra expenses like stock-based compensation.

How To Calculate EBITDA?

There exist two EBITDA calculation methods, one derived from Net income and the other from Operating income, both of which yield similar outcomes.

EBITDA = Net profit + Interest + Taxes + Depreciation + Amortisation

or

EBITDA = Operating Income + Depreciation + Amortisation

Operating income: It is a calculation that represents the portion of a company's revenue that will translate into profits. Comparable to a company's earnings before interest and taxes (EBIT), operating income is also known as operating profit or recurring profit.

Depreciation: This refers to the reduction in the value of physical assets over time due to usage, leading to the gradual deterioration of these assets.

Amortisation: It is the monetary method used to gradually reduce the value of intangible assets owned by a company.

Net profit: This refers to the income your business generates after deducting all operating costs, interest payments, and taxes during a specified timeframe.

Taxes: Comprise any central taxes and state or local taxes imposed in the region by the government and regulatory authorities.

Advantages Of EBITDA

• The utilisation of EBITDA is extensive, with various parties globally incorporating it into their evaluations, including both buyers and sellers. As a result, EBITDA serves as a valuable tool for diverse stakeholders in comparing different business valuations and making well-informed decisions.
• EBITDA eliminates unique and fluctuating variables inherent to individual businesses, such as tax rates, interest rates, depreciation, and amortisation. This standardized approach offers an accurate portrayal of a company's operational performance.
• The simplicity of EBITDA calculation and evaluation renders it accessible and highly informative. Its straightforward computations yield valuable insights into a company's financial health.
• Ultimately, EBITDA stands as a dependable metric for business valuation, allowing buyers to focus on the fundamental profitability of the company.

What Does EBITDA Not Tell?

• EBITDA disregards debt expenses by reinstating taxes and interest on earnings. It has the potential to conceal poor decisions and financial deficiencies.
• Relying on EBITDA might hinder your ability to secure a business loan, as loans are typically based on a company's genuine financial performance.
• As time passes, copyrights and patents expire, and the value and usefulness of machinery, tools, and other assets diminish. EBITDA fails to acknowledge or recognise these depreciation costs.
• EBITDA overlooks or conceals significant financial obligations associated with high interest rates.

Therefore, EBITDA serves as an effective method for assessing a company's underlying profit trends by excluding certain external factors. However, for a more thorough financial evaluation, investors and company owners should utilise additional, broader financial metrics. Because it may not consider the expense of capital speculations and investments like property and machinery.