Earnings before interest, taxes, depreciation, and amortization, or EBITDA, is a measure of a company’s operating efficiency. EBITDA is a way to measure profits without having to consider other factors such as financing costs (interest), accounting practices (depreciation and amortization) and tax tables.
Calculating EBITDA is usually a fairly simple process and, in most cases, requires only the information on a company’s income statement and/or cash flow statement.
The usage of EBITDA
EBITDA is probably the most used financial metric for startups and SaaS companies. It is well known by entrepreneurs and investors, usually used as the main indicator of operating efficiency for valuations and investment rounds.
It can also be used to compare companies against each other and against industry averages. In addition, EBITDA is a good measure of core profit trends because it eliminates some of the extraneous factors and allows a more “apples-to-apples” comparison.
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While EBITDA may be a widely accepted indicator of performance, using it as a single measure of earnings or cash flow can be very misleading. In the absence of other considerations, EBITDA provides an incomplete and dangerous picture of financial health.
A common misconception is that EBITDA represents cash earnings. EBITDA is a good metric to evaluate profitability, but not cash flow. EBITDA also leaves out the cash required to fund working capital and the replacement of old equipment, which can be significant.
How to calculate EBITDA?
To calculate EBITDA, a business must know its income, expenses, interest, taxes, deprecation (the loss in value of operational assets, such as equipment) and amortization, which is expenses for intangible assets, such as patents, that are spread out over a number of years. With those numbers in hand, the formula is: