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What is EBITDA?

EBITDA, very straightforward to calculate, is seen as a better performance measure than just looking at statutory profit.

What is EBITDA?

When reading the business news or looking at financial statements, there is often a reference to EBITDA. What does this mean, and how is it calculated?

Meaning of EBITDA

EBITDA stands for Earnings (E) Before (B) Interest (I), Tax (T), Depreciation (D), and Amortisation (A). It is similar to operating profit (earnings before tax and interest), but with further non-cash expenditure adjustments. It is widely used when calculating staff bonuses and is often used as a KPI (key performance indicator) for entities.

Why do we use EBITDA?

You may be wondering why entities use EBITDA rather than just operating profit. The reason is that depreciation and amortisation charges are often significant for entities, as most will hold many non-current assets (both tangible and intangible). This means that although these charges will lower profit, neither depreciation nor amortisation is paid to anyone. So if we want a sense of the cash generated by an entity, these will need to be excluded. EBITDA is seen as equivalent to cash and is a useful performance measure as it reflects the cash generated by an entity after paying necessary expenses.

Suppose you wish to remunerate staff based on bonuses. In that case, it is better to use a measure that reflects cash rather than profit due to these significant non-cash expenses that cannot be influenced by staff performance. Depreciation and amortisation reflect the spreading of an asset’s cost or value over its expected useful economic life.

How is EBITDA calculated?

To calculate EBITDA, you must start with profit before interest and tax. This is also known as operating profit. This figure represents the profit an entity generates after paying all of its expenses, but before the statutory deductions of interest (payable if an entity has debt), and tax (payable dependent on the tax laws in the jurisdiction in which the entity operates). Interest and tax cannot be easily managed from an operational point of view (although there are opportunities to look at funding mechanisms for entities and tax planning). Therefore, operating profit is seen as a better reflection of sustainable profit than net profit.

Once you have operating profit or earnings before interest and tax, you then add back the depreciation and amortisation cost for the period. As previously mentioned, these are often significant non-cash expenditures, with a large impact on profit but are not paid to anyone. Once you have added these figures back, you are left with your EBITDA.

Worked example

XY Plc has the following extract in its financial statements

 

$m

Revenue

450

Cost of Sales

(200)

Gross Profit

250

Distribution costs

(55)

Administrative Expenses

(100)

Operating profit

95

Finance costs

(10)

Profit before tax

85

Tax

(20)

Net profit

65

In addition, XY charged depreciation of \$10m on tangible non-current assets during the year and amortisation on intangible non-current assets of \$5m.

Calculation of EBITDA

To calculate EBITDA for XY, let’s start with an operating profit of \$95m. This is our EBIT (Earnings Before Interest and Tax). Then we add to this the depreciation and amortisation, giving the following EBITDA:

 

$m

Operating profit

95

Depreciation

10

Amortisation

5

EBITDA

110

As you can see, EBITDA is \$110m, which is higher than operating profit as we have excluded these large non-cash expenses. This can now be used to evaluate performance and potentially remunerate staff.

So, in conclusion, EBITDA is very straightforward to calculate and is seen as a better performance measure than just looking at statutory profit. It also allows us to see a broad equivalent to cash without looking at a statement of cash flows.

Anna Hardy Watmough
2 min read
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