What is EBITDA?

EBITDA (earnings before interest, taxes, depreciation, and amortization) is used as an indicator to assess the financial performance of a company. The figure includes interest expenses, taxes, depreciation, and amortization costs in addition to the net income. All the required information to calculate EBITDA will be available from the income statement and balance sheet.

EBITDA (earnings before interest, taxes, depreciation, and amortization) is used as an indicator to assess the financial performance of a company. The figure includes interest expenses, taxes, depreciation, and amortization costs in addition to the net income. All the required information to calculate EBITDA will be available from the income statement and balance sheet. 

EBITDA = net income + interest expenses + taxes + depreciation + amortization

It can also be calculated by adding depreciation expenses and amortization expenses to operating profit.

EBITDA = operating profit + depreciation + amortization

When and why is EBITDA used?

Net income is a better measure of the profitability of a business, but EBITDA is widely used in the financial industry. The main utility of the EBITDA figure is to compare the profitability of different companies. Here’s a look at each of the elements that become part of the EBITDA calculation:

  • Net income — The profitability of the business after every expense is accounted for. It is the best measure of a company’s profitability.
  • Interest expenses — Interest paid to service the firm’s debt. It will vary for different businesses according to the interest rate. In order to compare different companies, the profitability figure that is not affected by interest expenses on different principal amounts is the best.
  • Taxes — Taxes paid to the government. Companies operating in different areas will be subjected to different tax rates. Different states in the US will have different tax rates. It even varies according to the local jurisdiction. Companies in different countries are also subject to different tax rates. Other tax provisions like deferred taxes will make comparing companies even more complex. It's best to compare profitability between different companies before tax expenses.
  • Depreciation and amortization — The cost allocated to capital expenditures for tangible or fixed assets. There are different depreciation and amortization methods that can be used by accountants. Again, to compare the profitability of different companies, you should compare the profitability figures before depreciation costs.

To reach net income in the income statement, different costs are subtracted. These costs can differ based on where the company is located, how the company spreads the cost, manages debt, and pays taxes. Therefore, the profitability figure prior to these expenses is a more reliable metric to compare the profitability of different companies. EBITDA is used to compare the profitability of different companies, while net income is used to gauge the profitability of a single company.