There are many financial metrics available to analyze the profitability of a company. Each metric typically includes or excludes particular line items to arrive at its result.
EBITDA, EBITDAR, and EBITDARM are profitability indicators to help evaluate the financial performance and resource allocation for operating units within a company.
Below, we take a define each of these figures and see how they differ.
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 rent/restructuring costs (EBITDAR) is a variation of EBITDA whereby rent and restructuring costs are excluded.
EBITDAR can be calculated as:
EBITDAR = Net Income + Interest + Taxes + Depreciation + Amortization + Rent/Restructuring
It is useful for companies undertaking restructuring efforts since restructuring charges are typically one-time or non-recurring expenses. Removing the restructuring costs shows a clearer picture of the operating performance of the company and perhaps might help with obtaining financing from a creditor.
Earnings before interest, taxes, depreciation, amortization, rent/restructuring 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 major operating cost. Also, companies that require a large amount of storage space will also 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 for 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 figures such as EBITDA, EBITDAR, and EBITDARM.
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 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. 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.