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EBITDA definition

Description

EBITDA is a metric measure that is calculated by adding the net income to interest, income taxes, depreciation and amortization. It is a very popular and often used financial profitability measure. In order to calculate EBITDA, the data must be collected from the income statement and cash flow statement. EBITDA is mostly used to analyze and compare profitability between companies and industries because it helps to avoid the effects of financing and influence of depreciation and amortization accounting policy.

In other words, EBITDA is the sum of all profits before taking into account interest payments, income taxes, depreciation and amortization. This measure is interesting to the owners, creditors and investors as it shows the income from operating activities, eliminating the influence of depreciation and amortization. All this enables the value of this measure to be compared not only between the companies from the same industry, but also between different industry companies as well. This ability especially interests potential investors.

Norms and limitations

Higher value of EBITDA indicates potentially bigger cash flows. However EBITDA is not a relative ratio.

EBITDA is a metric measure that will not indicate how efficiently the assets and resources are used.

Formula

Net income (net profit, net earnings), usually called “the bottom line”, is a measure which is calculated by taking revenues (sales and other incomes) and adjusting them to the cost of sales, operating cost, depreciation and amortization, interest, taxes and other expenses.

Interest expense shows how much a company must pay the money it borrowed from banks and other creditors.

A tax is a measure that governments impose on financial income generated by all entities within their jurisdiction.

Depreciation and amortization - depreciation is a way to allocate the cost of a long term tangible asset over its useful life, as amortization refers to long term intangible assets.