The formula for EBITDA is:
EBITDA = EBIT + Depreciation + Amortization
Hence to understand EBITDA, it becomes logically important to understand EBIT or the Earnings before interest and taxes. Now, Earnings before interest and taxes (EBIT) is a measurement that is commonly employed in accounting and finance as an indicator of a company's profit. It includes all expenses except interest and any income tax expenses. In other words, EBIT is the difference between operating revenues and operating expenses.
EBITDA and EBITDA margins
EBITDA margin is a measure of a company's earnings before interest, taxes, depreciation, and amortization as a proportion of net sales or revenues that it has earned. What exactly does EBITDA indicate?
EBITDA provides an indication of how much cash a company earned from its core business, while EBITDA margin indicates how much cash the company earned from its core business in relation to its net sales. Note that net sales here is the sales (net of excise/GST).
The formula for EBITDA margin is:
EBITDA Margin = EBITDA / Total Revenue
Both the EBITDA and the EBITDA margin can be easily calculated using the EBITDA Margin Calculator or the EBITDA Calculator as the requirement may be.
HOW TO CALCULATE EBITDA?
You can either calculate EBITDA and EBITDA margins manually or by using the EBITDA Margin Calculator or the EBITDA Calculator. The use of calculators are recommended as they are quicker and also more accurate. But let us also understand the methodology that the EBITDA Margin Calculator and the EBITDA Calculator actually use and what goes on in the background before you get the output. There are basically two approaches.
Approach 1: Start from bottom-line and move up to EBITDA
The formula under this method is as under
EBITDA = Net Income + Interest + Taxes + Depreciation + Amortization
You essentially start with the net income or the net profit as you prefer to call it. In order to calculate EBITDA, add back the interest and tax items to the net income and also add back the depreciation and amortization (if any) to this number. The result you get is the EBITDA.
Approach 2: Start from the operating profits in this case
The formula under this method is as under
EBITDA = Operating Profit + Depreciation + Amortization
In this approach, start with operating profit or operating income and just add back the depreciation and amortization.
IMPORTANCE AND LIMITATIONS OF EBITDA.
On the positive side, EBITDA is important because it looks at the business from operating perspective. Also, it is very useful for capital allocation in case of multiple business lines and also very useful as an analytical tool for loss making companies or for projects with long gestations. However, EBITDA approach has its limitations too. Here are few of them.
The truth is that when you evaluate a business, outlays like taxes, interest, depreciation and amortization do matter a lot. Also, it often happens that businesses with huge debt or fixed assets can try and paint a rosy picture by using EBITDA instead of PAT. That is why, EBITDA is always best used in conjunction with other measures of profitability. Needless to say, your job of calculating these parameters / ratios is simplified by instruments like the EBITDA Margin Calculator or the EBITDA Calculator.
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