What Is EBITDA? Definition, Formula, & More

Why is EBITDA important?

EBITDA can be instrumental in assessing a business’s value and a borrower’s capacity to meet debt obligations. That’s because evaluating the profitability or value of a company when compared to other businesses can prove rather complicated; geography, tax requirements, and how individual businesses leverage their debt, equity, and cash might vary between the companies being evaluated, potentially skewing any comparison. 

EBITDA attempts to provide a relatively neutral value that ignores much of this nuance, focusing exclusively on operations rather than how much equipment a business might have or the subtleties of regional tax codes.

How to calculate EBITDA 

Determining EBITDA is a straightforward process that requires only a calculator and access to your business’s financial statements. In particular, you’ll need the net profit, interest, and tax values from the income statement and the depreciation and amortization figures from the cash flow statement. Of course, depending on how these totals are calculated, you might need to adjust the general line items, focusing specifically on:

• Net profit: This figure will record what is left of the firm’s total revenue after accounting for all of its expenses.
• Interest: Only the interest from short and long-term debt should be considered, ignoring other types, such as interest from accounts receivable (A/R).
• Tax: Specifically income tax, so do not factor in other taxes such as payroll, property, or sales.
• Depreciation and amortization: These account for the gradual, incremental loss of fixed and intangible assets, respectively — often reported as a single line item.

Once you’ve gathered the necessary information, plug it into the following formula to calculate your EBITDA. 

EBITDA formula

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

or

EBITDA = Operating Income + Depreciation + Amortization

EBITDA example

To put all of this into perspective, imagine that you’re an investor looking for your next opportunity, and after careful consideration, you’ve narrowed your options to one of two local barbecue restaurant chains: Porkpocalypse Inc. and Ribs ‘n Such. 

On paper, these organizations appear very similar. They draw in comparable revenues and profits and hold roughly the same value as fixed assets. In addition, since they operate in the same city, they experience an identical income tax burden. 

The major difference between the chains is how they fund operations, with Porkpocalypse leveraging debt and Ribs ‘n Such operating entirely on existing equity.

By calculating the EBITDA for these two organizations, you hope to determine which is more efficient at securing profits — a factor that will impact your final decision. And after obtaining the financial statements for both organizations, you begin your calculations.

By evaluating the relevant EBITDA scores, you quickly realize that Porkpocalypse is noticeably more efficient at capturing value despite recognizing net profits within $5,000 of each other, and you make your investment choice accordingly. 

Disadvantages of EBITDA

While useful in the above comparison, EBITDA doesn’t always tell the whole story. 

For example, EBITDA  ignores asset costs, acting as if any physical resources the business may own will retain their value in perpetuity, absolved from the degradations of use and time. As such, an organization that may have invested heavily in assets might have an attractive EBITDA value, even if it is currently operating at a loss.

Since this metric falls outside of Generally Accepted Accounting Principles (GAAP), how the figure is calculated — namely, what is or isn’t included in the various subtotals — can vary across businesses. Less transparent organizations can use this flexibility to create an inflated image of profitability and performance.

That’s why — to help limit any reporting shenanigans — the U.S. Securities and Exchange Commission (SEC) requires that any publicly-listed U.S. business that shares its EBITDA value must also explain how that figure was derived from its net income.

EBITDA and A/R automation

Your EBITDA depends on the accuracy of your reported financials. You’ll need precise revenue and profit figures that are up-to-date and based on actual data. Unfortunately, using disconnected, manual accounting processes will often invite errors when performing these calculations, particularly if billing or invoice data needs to be rekeyed or transcribed between back-office systems.

An accounting automation platform limits the potential for inaccurate data to undermine your reported totals. You’ll want software that can create automated A/R workflows to manage your invoicing and collection efforts and accelerate the payment process, netting more profit in a shorter period. 

Streamlining these operations will help your team to be more efficient, freeing them up for more important tasks.