Profitability and Coverage Analysis
2.7. Earnings before interest, taxes, depreciation and amortization (EBITDA)
Earnings before interest, taxes, depreciation and amortization (EBITDA) is an indicator of company’s profitability before interest, income tax expenses, depreciation and amortization.
EBITDA provides a measure of profitability by eliminating the impact of capital structures (e.g., interest expenses are excluded), income tax rates (e.g., income taxes are excluded), depreciation policies (e.g., depreciation expenses are excluded) and amortization expenses related to intangible assets (e.g., amortization expenses are excluded).
Sometimes EBITDA is treated as a rough estimate of cash flows; however, EBITDA does not necessarily represent true cash flows because items like changes in working capital and capital expenditures are not considered in EBITDA calculations.
EBITDA is a popular profitability measure because it allows comparing profitability of companies within the same industry, but with varying accounting (e.g., depreciation) policies. EBITDA may also be used in covenant calculations (e.g., stipulated in debt agreements).
EBITDA (Earnings before Interest, Taxes, Depreciation and Amortization) Formula
EBITDA = EBIT + Depreciation + Amortization |
EBITDA (Earnings before Interest, Taxes, Depreciation and Amortization) Example
Let’s go back to our Friends Company example. To determine the company’s EBITDA for 20X9, we will use the EBIT amount from the previous section, $4,440, and depreciation and amortization expenses from the statement of cash flows. Depreciation expense equals $1,300 and amortization expense equals $0. Thus, EBITDA for fiscal year 20X9 can be determined as follows:
EBITDA = $4,440 + $1,300 + $0 = $5,740
Important Notes
EBITDA is a non-GAAP (Generally Accepted Accounting Principles) measure of profitability. It can be a misleading measure of profitability in many circumstances, for example:
- EBITDA of a fixed asset intensive company may appear more attractive because significant depreciation related to fixed assets is excluded.
- EBITDA does not reflect a company’s ability to service all debts.
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