A:

When analyzing financial fitness, corporate accountants and investors alike closely examine a company's financial statements and balance sheets to get a comprehensive picture of its profitability. There are a number of metrics and corresponding financial ratios that are used to measure profitability. Typically, analysts look to the standardized profitability metrics outlined in the generally accepted accounting principles (GAAP), because they are easily comparable across businesses and industries, but some non-GAAP metrics are widely used.

One such non-GAAP metric is earnings before interest, taxes, depreciation and amortization (EBITDA). This calculation is used to measure a company's operational profitability because it takes into account only those expenses necessary to run the business on a day-to-day basis. However, a significant difficulty arises when using EBITDA as a profitability metric due to its inherent malleability. Because the calculation of EBITDA is not officially regulated, companies can massage this figure to make the business look more profitable.

For example, some businesses use only operating income as the sole source of earnings in the calculation. When using this definition of earnings, EBITDA is most closely related to operating profit. At least in theory, the exclusion of expenses for the amortization and depreciation of assets is the only real difference between these two figures. Since operating profit is reported on a company's income statement, the simplest way to calculate EBITDA is to start with the GAAP figure and work backwards.

EBITDA = Operating Profit + Amortization Expense + Depreciation Expense

For the fiscal quarter ended January 28, 2017, Barnes & Noble, Inc. (BKS) had an operating profit of \$128.79 million and depreciation & amortization expense of \$29.05 million. Using the above formula, Barnes & Nobles' EBITDA is \$128.79 million + \$29.05 million = \$157.84 million

However, many companies interpret the name of this metric literally, including all expenses and income sources regardless of their association with core operations. Under this method, EBITDA is calculated by starting with net income and adding back in taxes, interest, depreciation and amortization. Using this calculation, earnings includes any additional income from investments or secondary operations as well as one-time payments for the sale of asset.

EBITDA = Net Profit + Interest +Taxes + Depreciation + Amortization

In addition to its amortization and depreciation expenses, Barnes & Noble has net profits totaling \$70.28 million, a tax burden of \$56.43 million, and \$2.08 million in interest payments for the quarter. Under this calculation model, the EBITDA for this same fiscal quarter is \$70.28 million + \$2.08 million + \$56.43 million + \$29.05 million = \$157.84 million.

Depending on the particular circumstances, this figure can be manipulated to make a company look more profitable than it is. Sometimes, using both formulas for EBITDA may give you two different results. The difference between the two EBITDA calculations may be explained by the sale of a large piece of equipment or investment profits, but if that inclusion is not specified explicitly, this figure can be misleading. An unscrupulous company could easily use one calculation method one year and then switch the following year to make itself seem more profitable. If the calculation method remains constant from year to year, EBITDA can be a very useful metric for comparing historical performance.

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