EBITDA determines the profitability of a business and compares companies against each other and the industry average. For new entrepreneurs, EBITDA could be confusing. In this article, we will cover everything you need to know about it.
Here we will share what EBITDA means when it matters and how to calculate it.
What is EBITDA?
EBITDA is an acronym that stands for: Earnings Before Interest, Taxes, Depreciation, and Amortisation. It is a metric used to measure the company’s overall financial performance or profitability. To put simply, EBITDA is the company’s total revenue minus operating expenses.
You can find depreciation and amortisation, tax, and interest on the company’s income statement (also called profit and loss statement).
Before we go further, let’s quickly define what each term is in the EBITDA:
- Earnings: this refers to the business’s net profit.
- Interest: these are expenses that are related to the company’s debt.
- Taxes: relates to taxes affecting the businesses (company/income tax).
- Depreciation: is the reduction in the value of a tangible asset over time.
- Amortisation: refers to the process of gradually writing off the initial cost of an asset.
(Read our article here about Financial Terms Every Entrepreneur Should Know)
When does EBITDA matter?
EBITDA is widely used in the startup, tech and other industries to calculate a company’s growth potential.
Venture Capitalists (VC’s) use EBITDA to determine the value of a business. EBITDA will matter for a startup that is seeking investment.
Generally, EBITDA applies to:
- Startups looking for funding from VC’s or traditional investors;
- Investors reviewing a company’s operating and financial performance;
- Owners who are looking to exit their business.
How do you calculate EBITDA?
There are two formulas to calculate EBITDA. The first one uses the Operating Income, and the other starts with the Net Income.
Calculating EBITDA with Operating Profit
1. To get the operating Income:
Operating Profit = Sales – Operating Expenses
(Operating expenses is the overall sum of salaries, marketing/advertising expenses, rent & outgoings, business expenses and cost of sales)
2. Formula to calculate EBITDA:
EBITDA = Operating Profit + Depreciation + Amortisation
Calculating EBITDA with Net Income
1. To get the net Income:
Net Income = Total Revenue – Total Expenses
2. Formula to calculate EBITDA:
EBITDA= Net Income + Taxes + Interest Expense + Depreciation + Amortisation
When you get the EBITDA, you can now compute the EBITDA margin, which shows the company’s profitability as a percentage of revenue.
Calculating EBITDA Margin
EBITDA Margin= EBITDA/Revenue
The EBIT is used to measure the performance of a company’s core operational profits without the capital structure.
EBIT= Net Income + Interest + Taxes
EBITDA helps provide a picture of a business’s profitability and operating cash flow. Still, it doesn’t consider heavy debt or taxes that may affect how profitable a company is in the short term. However, it does show how well a business can turn profits and compare its efficiency against its competitors.
EBITDA is just one of the several ways to know the value of a company. Understanding the method and its pros and cons can help you end up with better valuations and decisions.
Are you looking to know the value of your business? Or are you seeking funding?
You can benefit from the expertise of a qualified business advisor, such as a VCFO. Get in touch with us today to see how we can help.