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1. Starting from Net Income.
2. Starting from Operating Income (EBIT)
The most common approach to calculating EBITDA is to start with net income and add back interest, taxes, depreciation, and amortization.
Formula:
EBITDA = Net Income + Interest + Taxes + Depreciation + Amortization
Example Calculation:
Suppose a company has the following financial data:
Alternatively, you can start from Operating Income (EBIT), which already excludes interest and taxes, and simply add depreciation and amortization.
Formula:
EBITDA = Operating Income (EBIT) + Depreciation + Amortization
Example Calculation:
If a company’s Operating Income is £240,000, with Depreciation of £20,000 and Amortization of £10,000, then:
EBITDA = £240,000 (Operating Income) + £20,000 (Depreciation) + £10,000 (Amortization)
EBITDA = £270,000
Both methods yield similar results, so the choice depends on available data.
EBITDA is widely used because it highlights a company’s core operational profitability by excluding non-operational factors. Here’s why it’s valuable:
EBITDA focuses on core earnings, allowing companies to be compared based on how efficiently they generate profits from primary business activities.
EBITDA removes the effects of financing (interest), taxes, and accounting methods, making it easier to compare companies within the same industry.
EBITDA provides an approximate idea of a company’s cash-generating potential, since it excludes non-cash expenses like depreciation and amortization.
Investors and analysts often use EBITDA in valuation multiples, such as the EV/EBITDA ratio, to assess whether a company is overvalued or undervalued compared to its peers.
Let’s say two companies in the same industry, Company A and Company B, have different financing structures and depreciation schedules.
EBITDA = £150,000 (Net Income) + £40,000 (Interest) + £60,000 (Taxes) + £25,000 (Depreciation) + £5,000 (Amortization)
EBITDA = £280,000
Although Company B has a higher net income, Company A has a higher EBITDA, suggesting it may be more operationally efficient when non-operational expenses are removed.
EBITDA = £180,000 (Net Income) + £10,000 (Interest) + £40,000 (Taxes) + £15,000 (Depreciation) + £10,000 (Amortization) EBITDA = £255,000
While EBITDA is a useful metric, it has some limitations that are important to consider:
EBITDA doesn’t account for capital expenditures (CapEx), which can be significant for capital-intensive industries like manufacturing or energy.
EBITDA doesn’t capture changes in working capital, so it may not reflect cash flow changes for companies with fluctuating working capital needs.
Excluding interest and taxes can give an overly optimistic view of a company’s financial health, as it ignores debt costs and tax obligations.
EBITDA excludes non-cash expenses but is not a true measure of cash flow. For a full picture, analysts should consider cash flow statements in addition to EBITDA.
EBITDA is often compared to other metrics. Here’s how it differs:
EBIT (Earnings Before Interest and Taxes): EBIT focuses on operating income, excluding interest and taxes but including depreciation and amortization. EBITDA adds back non-cash items, providing a closer look at cash potential.
Net Income: Net Income includes all expenses, providing a more comprehensive bottom-line figure. EBITDA is more focused on core operational earnings.
Cash Flow from Operations: This metric includes cash inflows and outflows, providing a truer picture of liquidity compared to EBITDA.
EBITDA is a powerful tool for assessing a company’s core profitability by focusing on operational earnings and excluding non-operational expenses. This metric simplifies comparisons across companies, making it especially valuable for investors and analysts who want to evaluate companies in similar industries. However, EBITDA should be used alongside other metrics—such as cash flow and net income—to gain a comprehensive view of a company’s financial health.
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