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How Ebitda Works

When you think of investment, you’ll likely think of cash flow, your net income, and any other revenues that are part of your usual corporate health. There’s one more measure to help you with investments and quarterly reports: Ebitda, otherwise known as earnings before interest, taxes, depreciation, and amortization.

If you’re looking to learn more about your taxes and your company in general, this is the measure to do it with, but there’s more to it than it looks.

How Ebitda Works

What is Ebitda?

First off, you already know that Ebitda stands for earnings before interest, taxes, depreciation, and amortization. This means that this measurement is a great way to measure your company’s general finance, and can sometimes be used as a substitute for net income.

That being said, Ebitda can possibly be misleading since it does not look at the cost of capital investments, such as property, plant, and equipment. It also ignores any expenses associated with debt by adding back the interest expense.

Still, you may find that it’s helpful when it comes to your corporation, and for knowing all of your earnings before you take into account any financial deductions.

Do I Need Ebitda?

In short, no. This isn’t a necessary measurement, and there’s not even any legal requirement for a company to disclose your Ebitda.

You can work it out using your financial statements though. Just look for the earnings, tax, and interest numbers on your income statements—you’ll be able to see the depreciation and amortization numbers in the notes too. It’s generally pretty easy to calculate your Ebitda with these numbers: just start with the earnings before interest and tax and then add back your depreciation and amortization.

How to Calculate Ebitda

It’s easy to calculate Ebitda using the numbers on your financial statements. Just start with your net income, add the interest, then the tax, and then the depreciation and amortization. This calculation will let your company perform a more straightforward comparison without some of the more extraneous factors that influence your finances.

Ebtida’s Origins

Ebitda was first prominent in the mid-1980s, and first became popular as a leveraged buyout that some financially distressed companies used to help with a restructuring of their finances. Back then, they could use Ebitda to calculate whether companies could really pay back the interest on any financial deals.

Initially, Ebitda was used to determine whether a company would be able to pay back its debt in the next year or two. By looking at this number, it’s possible for investors to understand whether heavier interest payments could be met after some restructuring. This made Ebitda popular in the 1980s to determine how debt could be used in a leveraged buyout.

Why is Ebitda Useful Now?

Ebitda was very popular in the 1980s in reference to buyouts, but it’s also a number that has become popular in many businesses today as it’s used to calculate a clearer understanding of any expenses of a business. This will let you know how your company is actually looking with the numbers, and will let you compare your company’s profitability to other companies more easily. Use it to compare to the enterprise value and revenue.

If your company doesn’t have very high net income, there’s a possibility that you might be able to use your Ebitda to highlight this number instead of needing to focus on a potential net loss. This doesn’t have to be malicious, but this is an indication sometimes that companies use to distract investors when there’s not any actual profit.

Of course, Ebitda is also a solid number to use when looking at profit growth, even if it can sometimes overshadow legitimate financial performance.

The Problems with Ebitda

The biggest issue with the Ebitda number is that it’s not an accurate representation for your company’s cash flow. It can make your company look like it has more money than it does, which means more money to make interest payments. In addition, it ignores the quality of your earnings, making your company look cheaper.

This means that while it can be used as an indication of how well your company is doing, there’s also a great opportunity for this number to mess up your taxes and to mislead you about the financial responsibility of your company.

Investors do need to keep an eye on Ebitda if a company begins to report more on this number, especially if they began to emphasize this number when they haven’t done so in the past. Be careful not to be distracted by this number, which will ignore the costs of assets and working capital, and only watch sales operations alone.

To Use Instead

As your company grows, you might instead consider using Ebit, which is earnings before interest and taxes, which is your net income before all of your tax expenses and interests have been deducted. This is a variation of Ebitda, but it might be more useful overall for your business.

Conclusion

There’s a lot that goes into reporting your company’s finances, and a lot that goes into what you report as well. That’s where Ebitda might come in, but just be aware of what this number is, why it might be helpful, and what problems are associated with it. It’s certainly an indicator of financial growth, but a different calculation might be better depending on your business.

James Jackson

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