The earnings before interest, taxes, depreciation, and amortization (EBITDA) formula is one of the key indicators of a company's financial performance and is used to determine the earning potential of a company. With EBITDA, factors like debt financing, as well as depreciation and amortization (D&A) expenses are stripped out when calculating profitability.
- There are two ways to calculate EBITDA—the first uses operating income as the starting point, while the second uses net income as the starting point.
- The two figures may yield different results depending on what's included in operating income.
- EBITDA can be used to analyze and compare profitability among companies and industries as it eliminates the effects of financing and accounting decisions.
- However, depreciation is not captured in EBITDA (as it's added back for the purposes of the calculation) and can lead to distortions for companies with a significant amount of fixed assets.
- Note that the EBITDA calculation is not officially regulated, which may allow companies to massage certain figures to make their company look more profitable.
Two EBITDA Formulas
There are two EBITDA formulas—the first formula uses operating income as the starting point, while the second formula uses net income.
EBITDA rose as a key figure used by analysts in the 1980s with the rise of leveraged buyouts. Distressed companies were not profitable, making them hard to analyze. EBITDA was created to help analyze whether these companies could pay back interest on the debt that would be used to fund the deals. Since then, analysts have continued to use EBITDA in an effort to determine how a company is really performing.
Using Operating Income
Both formulas have their benefits and drawbacks. The first formula is below:
EBITDA = Operating Income + Depreciation & Amortization
Operating income is a company's profit after subtracting operating expenses or the costs of running the daily business. Operating income helps investors separate out the earnings for the company's operating performance by excluding interest and taxes. Operating income, as the name suggests, displays the money a business makes from its operations.
Operating income is often calculated as sales less operating expenses, such as wages and cost of goods sold (COGS). Operating income is already figured before interest and taxes are taken out, thus, only D&A needs to be added to figure EBITDA.
Depreciation and amortization expense is often grouped into operating expenses on the incomes statement. Thus, the D&A figure is often counted under cash flows from operating activities on the cash flow statement.
Using Net Income
The second formula for calculating EBITDA is:
EBITDA = Net Income + Taxes + Interest Expense + Depreciation & Amortization
Unlike the first formula, which uses operating income, the second formula starts with net income and adds back taxes and interest expense to get to operating income. Like operating income from the formula above, the net income, tax expense, and interest expense figures can be found on the income statement.
The two EBITDA calculations can yield different results as net income includes line items that might not be included in operating income, such as non-operating income or one-time expenses (e.g. restructuring charges).
Below is the income statement for Walmart (WMT) as of Jan. 31, 2021.
Note that deprecation is often pulled from the cash flow statement, seen here:
Here is Walmart's EBITDA using operating income:
|Walmart EBITDA Using Operating Income|
|Operating Income||$22.55 billion|
|+ Depreciation & Amortization||$11.15 billion|
|= EBITDA||$33.70 billion|
EBITDA can also be calculated by taking net income and adding back interest, taxes, depreciation, and amortization. Walmart's EBITDA calculated from the fiscal 2021 data above using the net income formula is:
|Walmart EBITDA Using Net Income|
|Net Income||$13.71 billion|
|+ Depreciation & Amortization||$11.15 billion|
|+ Net Interest Expense||$2.19 billion|
|+ Income Taxes||$6.86 billion|
|= EBITDA||$33.91 billion|
Note that sometimes the EBITDA formulas can yield different results depending on whether the calculation uses the net income or the operating income formula. The difference in the EBITDA figure above for Walmart is $210 million in other gains. This $210 million is reflected in the net income, but not the operating income, hence the reason that the EBITDA figure using net income is higher.
Bringing It All Together
EBITDA can be used to analyze and compare profitability among companies and industries as it eliminates the effects of financing and accounting decisions. Investors and analysts might want to use multiple profit metrics when analyzing the financial performance of a company since EBITDA does have some limitations.
As stated earlier, depreciation is not captured in EBITDA (as it's added back for the purposes of the calculation) and can lead to distortions for companies with a significant amount of fixed assets. Companies with a large number of fixed assets and high depreciation expense would appear to have a higher EBITDA than a company that runs a business with virtually no fixed assets (all else being equal).
For example, oil companies have sizable amounts of fixed assets or property, plant, and equipment. As a result, the depreciation expense would be considerable, and with depreciation expenses removed, the earnings of the company would be inflated using EBITDA.
Going further, adding back D&A and taxes and interest can actually make some companies profitable (that would otherwise be unprofitable). EBITDA figures used by tech companies in the 2000s helped many dotcom businesses appear profitable when they were, in fact, not.
EBITDA Formula FAQs
How Do You Calculate EBITDA?
EBITDA can be calculated in one of two ways—the first is by adding operating income and depreciation and amortization together. The second is calculated by adding taxes, interest expense, and deprecation and amortization to net income.
Why Is EBITDA So Important?
EBITDA is used by analysts and investors to compare the profitability of companies by eliminating the effects of financing and accounting decisions. It's considered capital structure neutral and will not reward (or punish) a company for how it funds its business (i.e. equity vs. debt).
What Is a Good EBITDA?
A "good" EBITDA, as with most financial measures, depends on the company and the industry. EBITDA alone does not reveal how profitable a company is unless comparing the figure for the same company over various periods. EBITDA margin or an EBITDA valuation metric (such as EV/EBITDA) is much more useful when comparing companies. Again, however, a "good" EBITDA margin or valuation metric will depend on the industry the company operates in and how it compares to peers.
What Does EBITDA Mean in Business?
EBITDA stands for earnings before interest, taxes, depreciation and amortization. It's a popular profitability measure that allows for a more apples-to-apples comparison for companies. It measures a companies profitability based on generating potential absent its capital structure, taxes and non-cash depreciation or amortization charges.
The Bottom Line
The EBITDA calculation is not officially regulated, allowing companies to massage the figure to make their company look more profitable. An unscrupulous company could use one calculation method one year and switch the calculation the following year if the second formula made the company appear more profitable.
If the calculation method remains constant from year to year, EBITDA can be a very useful metric for comparing historical performance. Meanwhile, EBITDA is also a very popular tool for analyzing companies operating in the same industry, whether it be assessing margins or valuation. A very popular valuation metric, the enterprise multiple (EV/EBITDA) uses EBITDA to help determine whether a business is over- or undervalued.
Harvard Business School Online. "HOW TO VALUE A COMPANY: 6 METHODS AND EXAMPLES."
Securities and Exchange Commission. "Form 10-K."