EBITDA, short for earnings before interest, taxes, depreciation, and amortization, is a measure of profitability that zeroes in on core operational cashflow—with the “core” being everything that remains after omitting capital expenses and taxes.
In this guide, we’ll walk you through calculating this metric and explain why it matters to your business.
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Why Should Business Owners Understand EBITDA?
The number of financial measures and ratios accountants use can feel overwhelming. How many ways can we possibly repackage the question, “Is this company profitable?”
That said, there are a few bottom-line reasons for business owners to pay attention to EBITDA.
- Business valuation for sale: When selling a business, potential buyers may use EBITDA to assess its underlying profitability. Knowing your EBITDA helps you communicate the financial health of your enterprise and enhances its perceived value in the eyes of prospects.
- Attracting investors and creditors: Similar to how a potential buyer might assess your business, investors and creditors may use EBITDA to evaluate your ability to generate cash and service debt. A keen eye towards EBITDA can make your business more attractive and open opportunities for growth.
- Operational efficiency: EBITDA applies to more than buyers, investors, and creditors. It can help you assess the operational efficiency of your business. The metric provides insight into how your core operations are performing by isolating earnings from capital and tax-related expenses.
- Comparisons with industry benchmarks: Knowing your EBITDA allows you to compare your company with industry benchmarks. Whether you’re ahead or behind the curve, it’s important to know where you stand.
- Strategic decision-making: If you’re considering expanding your service line, opening new locations, or implementing cost-cutting measures, running projections as an EBITDA calculation can help make better-informed business decisions.
Why Use EBITDA Over Other Metrics?
All financial ratios have their unique use cases, advantages, and drawbacks. EBITDA is particularly useful for the following reasons:
- Cash flow representation: EBITDA is a proxy for cash flow. It’s not perfect, but it indicates how much cash is being generated from operational activities.
- Debt analysis: If a business has a significant debt, EBITDA is useful for assessing how readily it can cover those obligations. The debt-to-EBITDA ratio is an especially important metric lenders and investors use to assess a company.
- Communication with stakeholders: EBITDA is a succinct snapshot of financial health. A single number is easy to communicate with stakeholders, especially if they aren’t familiar with accounting concepts like depreciation and amortization.
How to Calculate EBITDA
To calculate EBITDA, begin with your net income, which is an all-encompassing measure summing revenues against all costs of doing business: overhead, employees, inventory, interest, taxes, amortization, depreciation, etc. Then, add the cost incurred from interest, taxes, depreciation, and amortization. EBITDA should be higher than your net income when you’re done.
In other words, tally your net income without considering the cost of interest, taxes, depreciation, or amortization.
Calculating EBITDA is easier said than done, however. Reliable net income figures require a systematized method of accounting for costs and revenue. Without one, accurately tallying everything can feel like looking for needles in a haystack.
If you feel your system could use an upgrade, consider reading our article on tracking business expenses.
EBITDA = Net Income + Interest + Taxes+ Depreciation + Amortization
EBITDA Calculation Example
Let’s assume we’ve already done the hard part of collecting the data and consider a hypothetical example.
Step 1: Calculate Net Income
|Cost of Goods Sold
Step 2: Add Interest, Taxes, Depreciation, and Amortization
Now that we have some real numbers to look at, it’s easy to see where EBITDA gets its name. Net income is considerably lower than EBITDA, because EBITDA is earnings before interest, taxes, depreciation, and amortization.
EBITDA margin measures a company’s operating profit as a percentage of revenue.
In the example above, we calculated a raw EBITDA of $150,000. But if we want to compare how efficient the business is to a company of a different size, we have to standardize our metric. This is where EBITDA margin comes into play.
EBITDA Margin Formula
To calculate EBITDA margin, divide raw EBITDA by total revenue and multiply by 100.
EBITDA Margin (%) = EBITDATotal Revenue x 100
For example, the EBITDA margin for this example business would be:
$150,000$500,000x 100 =30%
What Is a Good EBITDA Margin By Industry?
For a comprehensive look, the NYU Stern School of Business has compiled a table organized by industry with data accurate up to January 2023. The “EBITDA/Sales” column corresponds to the EBITDA margin we’re discussing here.
- In general, most industries fall between 10-30%.
- The average is in the US 15.68%.
- There are a handful of industries with exceptionally lower margins: airlines, food wholesalers, and retail.
- There are several industries with exceptionally higher margins: green energy, tobacco, and semiconductors.
EBITDA Margin By Industry: Selected Sectors
|EBITDA Margin (%)
|Healthcare Information and Technology
|Real Estate Development
EBITDA is a versatile metric. Depending on the scenario, it might be relevant to employ one or many of these variant EBITDA calculations when preparing for a conversation with investors or creditors.
Keep in mind that while variations can provide important insights, they also have their critics. Some argue that too many adjustments obscure a company’s true financial health; it’s crucial to understand the context and reasons behind any adjustment to EBITDA.
Adjusted EBITDA removes expenses that could distort the value of the calculation—for instance one-time, irregular, or non-recurring items. This is done on a case-by-case basis; there is no standard method of adjusting EBITDA.
It might seem manipulative to pick and choose certain expenses to omit, and unethical actors certainly do. But remember, the goal of EBITDA is to narrow the focus to core business activities. Just be sure to omit details in good faith and note them transparently to investors.
EBITDAR excludes rent in addition to the normal EBITDA calculation. This variation is used in industries where leasing or renting assets are significant expenses. For example, airlines commonly rent jetliners from one another.
The reason for omitting a significant expense is to allow investors to compare core activities absent a distortatively large line item.
EBITDAC was born in the wake of Covid-19 and measures profitability before interest, taxes, depreciation, amortization, and coronavirus. With such a significant disruption to normal business activities, it is reasonable to delineate between normal and extraordinary fiscal years.
This variation additionally excludes exploration expenses from the normal EBITDA calculation. The oil and gas industry often employs this metric due to the significant costs of exploration, so analysts can examine the impact of core activities without a distortionary expense.
Some companies have significant employee stock ownership plan (ESOP) expenses. This EBITDA variation excludes ESOP expenses.
EBIT vs EBITDA
EBIT is earnings before interest and taxes while EBITDA further excludes depreciation and amortization. Companies may choose to employ EBIT when they have significant capital expenditures (which are represented by depreciation and amortization costs) that they’d like to isolate from their core operational activities.
Focusing on core operational cash flow by excluding capital expenditures and taxes allows the focus to rest squarely on cash flow. EBITDA is important for business owners seeking a comprehensive view of their financial health. It helps one evaluate
business efficiency as well as provide potential buyers, investors, and creditors with relevant information.
If you’d like help with the nitty gritty details of accounting, consider reaching out to indinero’s expert accounting services team today.