Financial metrics
EBITDA
EBITDA is a measure of a company's operating performance that excludes interest, taxes, depreciation and amortisation to show the pure cash profit generated by its core business operations.
What is EBITDA?
EBITDA stands for Earnings Before Interest, Taxes, Depreciation and Amortisation. When you look at your profit and loss statement, the final net profit includes non-operating expenses and accounting adjustments. EBITDA deliberately strips these out. By ignoring interest and taxes, it removes the effects of your financing choices and local tax jurisdictions. By excluding depreciation and amortisation, it removes non-cash accounting rules related to your long-term assets. This exclusion is highly useful because it allows you to compare your core operational efficiency directly against other businesses, regardless of how they are funded or taxed. However, the standard criticism of EBITDA is that it can make a heavily indebted company look artificially profitable. Critics argue that interest and equipment wear are real costs, and ignoring them might hide underlying cash flow problems.
Net Profit + Interest + Taxes + Depreciation + Amortisation
A higher result indicates stronger operational profitability, but you must still ensure you have enough cash to cover the excluded debt and tax obligations.
How EBITDA works
To calculate this metric, you start with the figures on your standard income statement. The most common approach begins at the bottom with your net profit. You then work backwards by adding certain expenses back into that final number. First, you add back any income tax expenses, as these vary based on location and corporate structure. Next, you add back interest expenses paid on loans, which reflect your capital structure rather than operational success. Finally, you add back the non-cash charges of depreciation and amortisation. These charges represent the gradual loss of value in physical and intangible assets over time. Once you have added all four components back to your net profit, the resulting figure is your EBITDA.
- Locate your final net income at the bottom of your profit and loss statement.
- Add back all corporate income tax expenses paid or owed for the period.
- Add back any interest expenses incurred from bank loans or other debt facilities.
- Add back depreciation costs related to physical assets like machinery and vehicles.
- Add back amortisation costs associated with intangible assets like software or patents.
Worked example
Gulf Trading LLC reports a net profit of 50,000 for the year. To find their EBITDA, they must add back specific expenses. During the year, they paid 10,000 in interest on a business loan and 5,000 in corporate taxes. They also recorded 15,000 in depreciation for their delivery vans and 2,000 in amortisation for their accounting software. The calculation is 50,000 (net profit) + 10,000 (interest) + 5,000 (taxes) + 15,000 (depreciation) + 2,000 (amortisation). This results in an EBITDA of 82,000. This higher figure shows investors the true cash-generating ability of their core trading operations.
Why it matters for your business
Business owners should care about this metric because it is the primary number investors and buyers use to value a company. If you plan to sell your business or apply for major bank financing, lenders will look at this figure to determine your ability to repay debt. A strong operational profit margin gives you negotiating power. It also helps you measure internal performance year over year without the distortion of new loans or tax changes. Paper & Pen creates invoices, quotations and receipts, helping you maintain the accurate sales records needed to calculate these vital profitability metrics.
See also
Questions
Common questions
Is EBITDA the same as gross profit?
Can a company have positive EBITDA but negative cash flow?
Why do buyers use EBITDA multiples to value businesses?
Related terms
- Profit and loss statement A profit and loss statement is a financial report that summarises a company's revenues, costs and expenses during a specific period to show whether it generated a profit or incurred a loss.
- Net profit margin Net profit margin is a financial ratio that shows the percentage of revenue remaining after all operating expenses, taxes and interest have been deducted from your total sales.
- Depreciation Depreciation is an accounting method used to allocate the cost of a tangible physical asset over its useful life, reflecting how much of its value has been used up.
- Amortisation Amortisation is the accounting practice of gradually writing off the initial cost of an intangible asset over its useful life to match expenses with generated revenues.
- Working capital Working capital is the financial metric representing the difference between a business's current assets and its current liabilities, indicating its short-term liquidity and operational efficiency.
- Break-even point The break-even point is the exact moment when a business generates enough revenue to cover all its fixed and variable costs, resulting in neither a profit nor a loss.