There are many financial metrics available to analyze the profitability of a company. Each metric typically includes or excludes particular line items on the financial statements to arrive at its result.
EBITDA, EBITDAR, and EBITDARM are profitability indicators that help evaluate the financial performance and resource allocation of operating units within a company.
Below, each is defined, and their differences are examined.
- EBITDA is earnings before interest, taxes, depreciation, and amortization. It measures a company's profitability from its core operations.
- EBITDAR is a variation of EBITDA that excludes rental costs.
- EBITDARM reports earnings before taking into consideration the above costs as well as large rental and management fees.
- Critics of these metrics argue that they ignore essential expenses and therefore do not portray an accurate picture of a company's financial situation.
Earnings before interest, taxes, depreciation, and amortization (EBITDA) measures a company's profitability. EBITDA removes the costs of debt financing, tax expense, depreciation, and amortization expenses from profits. As a result, EBITDA can be beneficial since it provides a stripped-down view of a company's profitability from its core operations.
EBITDA is calculated by taking operating income and adding back depreciation and amortization. It became popular in the 1980s to show the potential profitability of leveraged buyouts. However, at times, it has been used by companies that wish to disclose more favorable numbers to the public.
Earnings before interest, taxes, depreciation, amortization, and rental costs (EBITDAR) is a variation of EBITDA whereby rental costs are excluded. Removing rental costs allows analysis of companies which may have similar operations but which choose to access assets differently—some companies may own assets while other companies rent. Excluding rentals allows comparison of profits on an apples to apples basis.
Earnings before interest, taxes, depreciation, amortization, rental costs, and management fees (EBITDARM) strips out rental costs as well as management fees.
EBITDARM is helpful when analyzing companies where the rent and management fees make up a substantial amount of operating costs. Hospitals, for example, typically lease the building space they use, meaning rental fees can be a large portion of operating costs. Also, companies that require a large amount of storage space will have high rental expenses. EBITDARM can help to strip out those costs allowing a better view of the operational performance of those companies.
It is primarily used for internal analysis and by investors and creditors. It is also reviewed by credit rating agencies (CRAs) to assess a company's debt servicing ability and credit rating.
Problems With EBITDA, EBITDAR, and EBITDARM
There are many critics against the use of EBITDA, EBITDAR, and EBITDARM.
EBITDA, EBITDAR, and EBITDARM are not generally accepted accounting principles (GAAP) measures, which means they have no standard or uniformity to them, and therefore can vary from one company to the next.
The first problem is that they may be distorted, as they do not provide an accurate picture of a company’s cash flow. Secondly, these figures are believed to be easy to manipulate. The final point is that they ignore the impact of real expenses, such as fluctuations in working capital. Critics also say that by adding back depreciation, recurring expenses for capital spending are ignored.
The Bottom Line
Used individually, EBITDA, EBITDAR, and EBITDARM are only one way to examine the financial health of a company, particularly the core operations of a business. But they are not meant to be used as the be-all and end-all of a company's performance. Investors and analysts must use a variety of different measures to do that.