What is EBITDA?
EBITDA is a measure of a company's profitability.
It stands for Earnings Before Interest, Taxes, Depreciation, and Amortization.
EBITDA is closely related to EBIT (earnings before interest and taxes), adjusted EBITDA (a normalized EBITDA), and cash-adjusted EBITDA (which adds deferred revenue to predict a company's future EBITDA).
But you don't need to worry about all of that just yet.
All you need to know for now is that EBITDA is a profitability indicator.
The higher EBITDA, the more profitable the company will likely be.
How to calculate EBITDA
EBITDA is super easy to calculate.
Here's the formula for calculating EBITDA:
EBITDA = Earnings + Interest expense + Tax expenses + Depreciation expenses + Amortization expenses.
Let's break down each of those terms a little more.
What defines earnings?
Earnings are generally going to be net income.
You can read your company's net income right off the income statement or statement of cash flows.
Check out the net income section of this post for more info on net income.
Interest, taxes, and non-core business operations
Interest and taxes are non-core business expenses that you add to net income (or earnings) to get EBIT.
(You'll get EBITDA once you add depreciation and amortization figures.)
A business can incur an interest expense on anything it's borrowed. Here's a non-exhaustive list of financing costs that incur interest:
- Convertible debt
- Lines of credit
Likewise, taxes are costs imposed by the government that a business is obligated to pay. Here's a non-exhaustive list of common taxes businesses are expected to pay:
- Income taxes (sometimes called corporation taxes)
- Sales tax (sometimes called VAT, value-added tax)
- Property taxes
- Excise taxes
- Employment taxes
- Dividend tax
- State income taxes
- Federal income taxes
- Local taxes
As you can see, there's a lot here! It's worth noting that a company's income tax expense is among its higher taxes.
These non-operating expenses all get added to earnings when calculating EBITDA.
What are depreciation and amortization?
Depreciation and amortization expenses represent the loss of value of an asset.
A depreciation expense is a loss of an asset's value over time.
An amortization expense is the method used to decrease the asset's cost over time.
So depreciation deals with value, while amortization deals with cost.
Okay, clear enough, but what does that difference look like in practice?
Depreciation deals with physical equipment: the value of a car decreases with age. That's depreciation.
But amortization deals with intangible assets, like customer lists. A list of potential customers in a company with a small target market (such as an ABM SaaS company) gets less valuable over time because it becomes more inaccurate (new potential customers are created, people change jobs, and so on).
If you think of amortization as "depreciation, but for intangible assets," you're probably okay.
Now that you know what goes into EBITDA, how do you interpret it?
Fortunately, EBITDA is super easy to interpret.
Higher EBITDA is better.
Okay, really. Higher in comparison to what?
Well, in comparison to this company's past performance.
(If you want to use EBITDA to compare one company's financial performance to another, you should use adjusted EBITDA. More on that in a second.)
A year-on-year growing EBITDA is a good indicator of a company's financial health. It indicates gross profit increases, revenue growth, higher net earnings, and more.
Of course, you can always supplement EBITDA with cash-adjusted EBITDA as a more realistic way to forecast operating profits.
Advantages of EBITDA
Since EBITDA shows net income before non-cash expenses, it's a good indicator of a company's ability to generate revenue. This also makes a EBITDA a good measurement of that company's core business operations.
Moreover, EBITDA is a simple metric to get. You can calculate it off the income statement in under a minute. Just take that company's earnings and add back in interest, taxes, depreciation, and amortization.
Moreover, EBITDA is used in a few important financial ratios that help determine a company's valuation, like the EBITDA multiple.
Limitations of EBITDA
EBITDA can be misleading because it isn't a GAAP (generally accepted accounting principle) metric. There's no standard list of what you can or can't include in your EBITDA calculations, so some creative accounting practices can significantly misrepresent EBITDA.
Moreover, EBITDA doesn't tell the full story. A highly leveraged company, for example, could have the same EBITDA as a company with little-to-no debt.
But one of those companies is a risky investment. The other is comparatively safe.
Finally, EBITDA doesn't give you any insight into a company's cash flow. So while it could be earning a lot of money, it might also be spending a lot.
EBITDA doesn't include overhead like administrative expenses or payroll, so you'll need to investigate a company's free cash flow to better understand the overall financial situation.
That's not to say EBITDA is bad.
But you should always evaluate a company's EBITDA in the context of other financial metrics.
EBITDA vs. EBIT
EBIT is EBITDA without depreciation and amortization added.
Here's the formula:
EBIT = net income + interest + taxes
That would be all there is to it...but it turns out that EBIT is used more than EBITDA in certain financial ratios.
For example, the EBIT margin, interest coverage ratio, fixed interest coverage ratio, fixed charge coverage ratio, times interest earned ratio, and financial leverage ratio all use EBIT.
But the only ratios that used EBITDA are the EBITDA multiple (also called the EV:EBITDA ratio) and the earning multiple.
For most companies, EBITDA will be higher than EBIT, so CFOs prefer to report EBITDA. But it's worth looking at both.
EBITDA vs. adjusted EBITDA
Adjusted EBITDA is a "normalized" version of EBITDA that excludes one-off, irregular, and non-recurring expenses (or appreciations).
This makes adjusted EBITDA a much better metric to compare companies in similar industries. It's inherently less noisy.
It's also super easy to calculate:
Adjusted EBITDA = EBITDA ± Adjustments
Because this is also a non-GAAP metric, there's no standard list of what those adjustments can be.
And that's sometimes the point: those adjustments are meant to be irregularities and non-standard.
For most companies, adjusted EBITDA is higher than EBITDA, so it's generally better to report if, for example, you're using EBITDA as a valuation signal.
Adjusted EBITDA is better for companies that trade based on estimated net income as it's considered a more realistic metric than EBITDA.
But more on that later.
EBITDA vs. cash-adjusted EBITDA
Cash-adjusted EBITDA is just EBITDA adjusted for deferred revenue.
It's more common in SaaS than in other fields, but that doesn't make it less important.
Cash-adjusted EBITDA is super easy to calculate. Just take your rolling 12-month average EBITDA and add your year-on-year deferred change in revenue.
Here's the formula:
Cash-adjusted EBITDA = 12-month rolling EBITDA + YoY change in deferred cash
Because you're always adding, cash-adjusted EBITDA will be higher than EBITDA for growing companies. Comparing the two is a good, immediate flag to read a company's performance.
Cash-adjusted EBITDA is a safe forecast for your company's future EBITDA. In this way, it can be considered a pro forma metric.
What is net income?
Net income, sometimes called net profit, is the difference after all expenses have been subtracted from revenue.
So it's super easy to calculate.
Net income = revenue - expenses
You might also have heard "net income earnings," or "earnings." These terms are the same and you can use them interchangeably.
The important thing to remember is that net profit is a "bottom-line" item. It's synonymous with both a company's profit and that company's total earnings.
Where is net income on the cash flow statement?
Net income is carried over from the income statement to become the first item on the cash flow statement.
So you can read net income from your company's financial statements.
What is Cost of Goods Sold (COGS)?
Cost of Goods Sold, commonly abbreviated as COGS, is the cost it takes to make a sale.
This includes the cost of acquiring, preparing, and storing inventory but not the cost of marketing, selling, or distributing.
Salaries are included in COGS if they're directly related to making a product. For example, you'd include payroll for the engineering team in a SaaS company's COGS, since that's the cost of preparing the product.
(Indirect expenses like the salaries for administrative workers, bookkeepers, and marketing are generally part of SG&A.)
COGS is important because you subtract it from your revenue to get your gross income.
What are operating expenses?
Operating expenses (OPEX) are anything that the business needs to spend money on to run.
Here's a non-exhaustive list of common operating expenses:
- Rent and utilities
- Equipment and software
- Sales and marketing
- Step costs
- Research and development
Operating expenses differ from capital expenditures (CAPEX) because CAPEX are investments.
Some examples of non-operating expenses are interest charges (and other costs of borrowing) and losses on the disposal of assets.
In other words: most of what you add back to net income to get EBITDA.
It's important to know about operating expenses because subtracting them from top-line revenue is important for accurately depicting your company's net income.
What's the difference between net income vs. net profit?
Net income and net profit are the same and you can use the terms interchangeably.
"Net profit" might feel like a more clear term to use, as "income" in common vernacular refers to "money paid" while "profit" is generally closer to "money you get to keep," but there's no hard and fast rule.
Use which one feels more natural.
What's the difference between net income vs. gross income?
Gross income is how much money your business has after deducting the cost of goods sold from total revenue.
Net income is gross income minus all the other expenses, too.
You'll calculate gross income on the income statement before you get to net income.
So it's an important stepping stone to an eventual net income calculation.
What's the difference between net income vs. operating income?
Operating income is revenue minus operating expenses, or the cost of doing business.
Net income is operating income minus non-operating expenses, like interest and taxes.
Operating income is calculated by subtracting operating expenses, depreciation, and amortization from gross profit.
Here's the formula:
Operating income = revenue - COGS - operating expenses - depreciation and amortization expenses
And here's another way to think of operating income:
Operating income = EBIT - COGS
Why does this work?
Because EBIT is just revenue plus interest and taxes. These are both non-operating expenses, so don't subtract them from operating income.
What's the difference between net income vs. operating profit?
Operating profit and operating income are the same.
Net income is the profit remaining after all costs incurred in the period have been subtracted from revenue generated from sales.
Therefore, operating profit is one of the many numbers you'll calculate as you go from total revenue to net income.
What's the difference between net income vs. operating revenue?
Operating revenue is the total cash inflow from your primary income-generating activity.
It's more or less equivalent to operating income.
How does Earnings per Share (EPS) relate to net income?
Earnings per share (EPS) is a company's net income (or net profit) divided by outstanding shares.
So a company with 200,000 shares but a $1,000,000 profit would have an EPS of $5 because $1,000,000/200,000 = $10/2 = $5.
Here's the formula for calculating EPS:
Earnings per share (EPS) = net income ÷ Number of Shares
Like EBITDA, EPS is a profitability metric. The higher a company's EPS, the more profitable it's considered.
EBITDA vs. net income: the key differences
The key difference between EBITDA and net income?
EBITDA is net income BEFORE taking out interest, tax, depreciation, and amortization expenses.
So EBITDA will almost always be higher than net income.
As we've seen, there are a few other key differences:
- Net income is a component in EPS, while EBITDA signals a company's earning potential.
- EBITDA is easier to understand because no depreciation or amortization is included.
- EBITDA measures the financial performance of startup and high-growth companies (and SaaS companies), but net income is used everywhere.
How do you convert EBITDA to net income?
Converting EBITDA to net income is easy and has to do with the formula for EBITDA.
Recall that EBITDA = net income + interest + tax + depreciation + amortization.
So deriving the formula for net income is easy. Just take out all the stuff that's been added in.
Net income = EBITDA - interest - tax - depreciation - amortization.
Why do we use EBIT or EBITDA instead of net income?
One of the biggest reasons for using EBITDA instead of net income is that EBITDA excludes depreciation and amortization, which can be tricky to nail down. There's no science to assigning financial values to either of those, so they introduce unnecessary noise.
Likewise, interest and taxes vary depending on where a company is based, the market conditions under which it raised capital, and many other factors. That's also noisy, so we exclude them.
Finally, we can normalize EBITDA values to make them easier to compare to similar companies. You can't do that with net income, so it's inherently a less useful metric.
EBITDA and business valuation
Both EBITDA and net income play a big role in business valuation, but EBITDA is becoming increasingly important.
In this section, we'll explain why EBITDA is so important for determining the valuation of a company.
EBITDA margin, also known as the enterprise value (EV) to EBITDA ratio, is a financial ratio that shows how desirable a company is as an acquisition target.
It's super easy to calculate:
EV:EBITDA ratio = EV ÷ EBITDA
You can calculate EV by adding market capitalization to debt and subtracting cash and cash equivalents.
So the question becomes:
Do you use EBITDA, adjusted EBITDA, or cash-adjusted EBITDA?
And the answer is: it depends.
To look like a more desirable acquisition target, you want to use adjusted EBITDA. This is usually higher than normal EBITDA, so the resulting ratio will be lower. A low EBITDA margin suggests stock is undervalued, which makes a company a low risk for acquisition.
However, this is tantamount to selling at a discount.
If you're trying to squeeze as much money out of an acquisition as possible, using plain EBITDA---a smaller denominator---will give you a higher EBITDA multiple.
To get your company's valuation, simply multiply its EBITDA by its EBITDA multiple.
Here's a list of common EBITDA multiples by industry for Fortune 500 companies in the United States.
Now you know all about the difference between EBITDA vs. net income.
You also know about the other forms of EBITDA like EBIT, adjusted EBITDA, cash-adjusted EBITDA, and the EBITDA margin.
Likewise, you know how net income relates to net profit, operating income, gross profit, and earnings per share.
And if you're interested in getting faster at calculating EBITDA (and other financial metrics), you should consider Cube.
Cube is the first spreadsheet-native FP&A platform designed by finance for finance that connects to all your source systems, organized and cleanses your data, and lets you keep your preferred Excel environment while also making it easy to collaborate with the rest of the organization in Google Sheets.
Click the banner below to request a free demo.