What is EBITDA? A Simple Guide to Understanding and Calculating It

If you have ever switched to a financial markets news channel then it is highly likely that you might have heard the lingo ‘EBITDA’ many times from the panelist. Isn’t it? So what’s the hype about EBITDA in business? Do you want to know the significance of the same in your business? That’s what we are going to discuss in this blog. 

Briefly, EBITDA stands for Earnings Before Interest, Taxes, Depreciation and Amortization. It is a significant financial metric that tells you the overall economic performance of a company. To know how to calculate, keep reading this blog down further. 

What is EBITDA? 

EBITDA stands for Earnings Before Interest, Taxes, Depreciation, and Amortization, a financial metric that companies use to know their economic performance. 

Additionally, it gives an overview to the investors and other stakeholders about the company’s profitability. However, it does not provide a complete picture of a company from a financial standpoint because it does not take account of cash flow. 

How is EBITDA Calculated

Let’s assume that we have an imaginary company ABC Pvt. Ltd. and this is important financial data of the company. 

Particulars	Amount
Total revenue	2,000,000,000
Cost of revenue	1,200,000,000
Operating Expense	476,000,000
Selling, general and administrative expenses	112,000,000
Interest expense	6,000,000
Income tax	114,000,000
Income from operations	230,000,000
Net income	226,000,000

In EBITDA (Earnings Before Interest, Taxes, Depreciation and Amortization), income tax, interest and amortization are not deducted. Thus, the formula would be: 

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

EBITDA: 270,000,000 (assuming Depreciation & Amortization = 40,000,000)

EBITDA Margin 

EBITDA Margin establishes a relationship between a company’s earnings and total revenue. It indicates how much profit in cash a company can gain in a year. 

Investors, financial analysts and stakeholders more often use this metric to compare financial performance of the company to its competitors in a given industry. 

Here is the EBITDA margin formula:

EBITDA Margin = EBITDA / Aggregate Revenue

It is to be noted that a company with comparatively larger margin would be preferable by the investors from growth potential. Even if you look out for an angel investor, they look for the same before making an investment. 

Let’s understand with an example; 

For example, the EBITDA of XYZ Private Limited is determined to be Rs. 500,000 and their aggregate revenue is Rs. 5,000,000. 

On the other hand, PQR Private Limited registered EBITDA of Rs. 900,000 and Rs. 100,0000 as their aggregate revenue. 

As per the formula, 

EBITDA margin for XYZ Private Limited = EBITDA / Total Revenue

= 500,000/5,000,000

= 10%

EBITDA margin for PQR Private Limited = 900,000/100,0000

= 90%

The above data says PQR Pvt. Ltd. would be preferred over XYZ Pvt. Ltd. by the investors. Because, the former company is financially more efficient.  

Tip: Boost your company’s EBITDA by using various cost control methods and track the progress with expense tracking using accounting software.

EBITDA Coverage Ratio

EBITDA-to-interest coverage ratio or EBITDA coverage ratio is a financial metric that is used to assess a firm’s financial capability. It examines if the pre-tax income would be enough to pay off the firm’s interest-oriented expenses. 

The EBITDA coverage ratio formula is as follows: 

EBITDA Coverage Ratio = (EBITDA + Lease Payments)/ (Interest Payments + Principal Payments + Lease Payments)

It must be noted that if the answer to the above ratio is one or greater than one, it means that the company is in a good position to pay interest on loans and is able to repay its liabilities. 

Advantages of EBITDA 

The following are the benefits of EBITDA:

• Offers an overview of the business’s performance and its effectiveness 
• Represents the actual value of the company’s cash flow

Disadvantages of EBITDA 

The following are the disadvantages of EBITDA:

• Companies are required to use other financial metrics to assess their actual economic performance.
• It does not consider depreciation and amortization as real expenses while calculating the company’s financial performance. 

Summing Up

So this was all you needed to know about EBITDA (Earnings Before Interest, Taxes, Depreciation and Amortization). We hope that after reading this blog, you will be able to make the same decisions for your company and know your overall financial health. If you have doubts or are struggling with anything, do reach out to us. We would be happy to assist you. If you are facing difficulties in recording and maintaining your company’s financial records, sign up with Munim Accounting and Billing software right away. 

FAQs on EBITDA 

What is the EBITDA margin? 

EBITDA Margin is a financial KPI that represents the company’s revenue remaining as profit after subtracting operating expenses but excluding taxes, depreciation and amortization. 

What does EBITDA mean?

EBITDA is an alternative way of gauging financial performance of a company. It is the earning of a company calculated before paying taxes, depreciation and amortization. 

What is EV EBIDTA?

EV/EBITDA is the ratio of Enterprise Value (EV) to the EBITDA. It is normally used at the time of mergers and acquisitions to analyze a company’s growth. 

What is amortization in EBITDA? ​

The acronym EBITDA stands for ‘Earnings Before Interest, Taxes, Depreciation, and Amortization’. Amortization refers to the recognition of gradual expenses on intangible assets associated with the assets over a set period of time. These assets include patents, trademarks, copyrights and goodwill. 

What is a good EV EBITDA ratio? ​

Anywhere between 10x to 15x EV by EBITDA ratio are considered to be a fair value for a company. 

What is adjusted EBITDA?​

Adjusted EBITDA is a more advanced financial metric than the traditional EBITDA as it takes its earnings and add back interest payment, depreciation charges and taxes.  

Is EBITDA and operating profit the same​? 

No, EBITDA and Operating Profit are not the same. EBITDA is a bit of a cash-centric metric while Operating Profit reflects the true profitability of a company.