What is ‘EBITDA – Earnings Before Interest, Taxes, Depreciation and Amortization’
EBITDA stands for earnings before interest, taxes, depreciation and amortization. EBITDA is one indicator of a company’s financial performance and is used as a proxy for the earning potential of a business, although doing so has its drawbacks. Further, EBITDA strips out the cost of debt capital and its tax effects by adding back interest and taxes to earnings.
Explaining ‘EBITDA – Earnings Before Interest, Taxes, Depreciation and Amortization’
Example of EBITDA
A retail company generates $100 million in revenue and incurs $40 million in product cost and $20 million in operating expenses. Depreciation and amortization expense amounts to $10 million, yielding an operating profit of $30 million. The interest expense is $5 million, leading to earnings before taxes of $25 million. With a 20% tax rate, net income equals $20 million after $5 million in taxes are subtracted from pretax income. Using the EBITDA formula, we add operating profit to depreciation and amortization expense to get EBITDA of $40 million ($30 million + $10 million).
The Drawbacks of EBITDA
EBITDA is a non-GAAP measure that allows a greater amount of discretion as to what is and what is not included in the calculation. This also means that companies often change the items included in their EBITDA calculation from one reporting period to the next.
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- EBITDA, EBITA, or EBIT? – papers.ssrn.com [PDF]
- Ebitda/Ebit and cash flow based ICRs: a comparative approach in the agro-food system in Italy – journals.muni.cz [PDF]
- The prevalence and validity of EBITDA as a performance measure – www.cairn.info [PDF]
- EVA, not EBITDA: A New Financial Paradigm for Private Equity Firms – onlinelibrary.wiley.com [PDF]
- The prevalence and validity of EBITDA as a performance measure – papers.ssrn.com [PDF]