Definition of EBITDA
EBITDA stands for Earnings before Interest, Taxes, Depreciation, and Amortization. It refers to the earnings of a company before interest, taxes, depreciation, and amortization are deducted.
That is, it is understood as the gross operating profit calculated before the deduction of financial expenses and accounting deductions.
Although it is not part of the income statement of companies, it is a widely used indicator as a reference to its operating performance. More specifically it measures a company’s ability to generate cash from its operation.
Most common EBITDA formula is as follows:
EBITDA = Net Income + Interest exp + Taxes + Depreciation exp + Amortization exp
EBITDA = Operation income + Depreciation exp + Amortization exp
Follow the steps below for EBITDA calculation:
- First, Calculate the EBIT of the company by adding interest and taxes to its Net income.
- Second, Add depreciation expenses to EBIT.
- Third, Add the amortization expenses to the EBIT.
- Finally, the Sum of all the above is EBITDA.
Because depreciation and amortization are added, this approximates the concept of operating cash flow. This data allows making a better comparison between different companies. And it purifies the effect of different tax systems and accounting depreciation and amortization, as well as the financial leverage between companies.
EBITDA could be misleading!
To better understand EBITDA, let us clarify several points. Otherwise, it could mislead and confuse its purpose.
- The objective of EBITDA is not to measure the liquidity of the company, because although it includes provisions and amortizations, it does not take into account other cash outflows such as financial payments or sales and purchases that have not yet taken effect.
- By not considering the indebtedness of the company, it is possible that a large EBITDA is the result of a high degree of leverage.
- When eliminating productive amortizations, it does not take into account the productive investments made in the past or in the current period.