In business valuation, there are multiple factors to consider when analyzing a company’s value and financial health. Net income, revenue, and cash flow all are important to look at in reports each quarter. However, a new statistic that has become crucial in finance is EBITDA.
Albeit a long-looking acronym, EBITDA in finance is a relatively simple metric. Here’s what you need to know about EBITDA in Finance, and how financial experts use it to analyze companies each quarter.
What is EBITDA in Finance
EBITDA stands for Earnings Before Interest, Taxes, Depreciation, and Amortization. This is an overall measure of a company’s financial performance which consists of multiple smaller metrics. Here is a breakdown of each integral letter in EBITDA, and what each means:
- EBI- Earnings before interest: Include business expenses caused by interest rates, including interest on loans by banks or third-party lenders.
- T- Taxes: Comprise any federal income taxes and state or local taxes imposed in the region by the government and regulatory authorities.
- D- Depreciation: An expense that indicates the reduction in the value of fixed company assets. It is a non-cash expense that signifies asset value reduction.
- A- Amortization: Another noncash expense that involves the cost of intangible assets. It can be defined as a process that gradually writes off the initial cost of an asset.
EBITDA focuses on the financial outcome of operating decisions. It does this by not including non-operating management decisions. These include tax rates, interest expenses, and significant intangible assets.
How Do You Calculate EBITDA?
Accountants employ the below two formulas to calculate the EBITDA value.
- EBITDA = Net Profit + Interest + Taxes +Depreciation + Amortization
- EBITDA = Operating Income + Depreciation + Amortization
After calculating EBITDA, you must determine if the EBITDA you have calculated reflects a good and profitable standing or not. To determine the amount of cash profit that a company makes in a year, some companies analyze EBITDA margin. This determines the percentage of calculated EBITDA against the overall revenue generated by the company. You can calculate the EBITDA margin with the formula below. The higher the margin percentage, the higher the growth potential.
EBITDA Margin = Calculated EBITDA / Total Revenue
Understanding EBITDA calculation and evaluation is important for business owners Firstly, it provides an idea of the company’s value. Additionally, EBITDA demonstrates the company’s worth to potential buyers and investors.