Complete explanation of EBITDA in Finance

What is EBITDA stand for?

EBITDA stands for “earnings before interest, taxes, depreciation, and amortization.” In finance, it is a measure of a company’s profitability that is calculated by adding back the expenses that are not related to the company’s core operations. This allows investors to see how much money the company is making from its core business operations, without being influenced by factors like taxes and interest on debt. EBITDA is often used to compare the profitability of different companies, or to see how a company’s profitability has changed over time.

The key differences between EBITDA, EBT and EBIT:

EBITDA, EBT, and EBIT are all measures of a company’s profitability. The main difference between these measures is the expenses that are included or excluded in the calculation.

• EBITDA stands for “earnings before interest, taxes, depreciation, and amortization.” It is a measure of a company’s profitability that is calculated by adding back the expenses that are not related to the company’s core operations. This allows investors to see how much money the company is making from its core business operations, without being influenced by factors like taxes and interest on debt.
• EBT, or “earnings before taxes,” is similar to EBITDA, but it does not include expenses for depreciation and amortization. This measure allows investors to see how much money the company is making from its core operations, before taxes are taken into account.
• EBIT, or “earnings before interest and taxes,” is the most commonly used measure of a company’s profitability. It is calculated by adding back any interest expense and taxes paid, but it does not include expenses for depreciation and amortization. This measure allows investors to see how much money the company is making from its core operations, before accounting for interest and taxes.

In general, EBITDA is the most comprehensive measure of a company’s profitability, as it includes all expenses that are not related to the company’s core operations. EBT is a slightly less comprehensive measure, as it does not include expenses for depreciation and amortization. EBIT is the least comprehensive measure, as it only includes expenses for interest and taxes.

How to calculate the EBITDA for a company?

To calculate a company’s EBITDA, you first need to determine its earnings before interest and taxes (EBIT), which can be found on the company’s income statement. To do this, start with the company’s net income, and then add back any interest expense and taxes paid. Next, add back any depreciation and amortization expenses, which can typically be found on the company’s income statement or in its financial footnotes. The resulting number is the company’s EBITDA.

Here is an example of how to calculate EBITDA:

1. Start with the company’s net income for the period being analyzed, which can be found on the income statement. Let’s say the company’s net income is $1 million.
2. Add back any interest expense. Let’s say the company paid $200,000 in interest expense.
3. Add back any taxes paid. Let’s say the company paid $300,000 in taxes.
4. Add back any depreciation and amortization expenses. Let’s say the company had $400,000 in these expenses.
5. The company’s EBITDA is equal to $1 million + $200,000 + $300,000 + $400,000 = $2 million.

In this example, the company’s EBITDA is $2 million. This means that the company made $2 million in profit from its core business operations, before accounting for expenses like interest, taxes, depreciation, and amortization.

Real world example of calculating EBITDA like Microsoft company:

(The below data is for demonstration purpose only)

To calculate Microsoft’s EBITDA, we would need to first find its earnings before interest and taxes (EBIT), which can be found on the company’s income statement. We would then add back any depreciation and amortization expenses, which can typically be found in the company’s financial footnotes. Here is an example of how to calculate Microsoft’s EBITDA:

1. Start with Microsoft’s net income for the period being analyzed, which can be found on the company’s income statement. Let’s say the company’s net income is $40 billion.
2. Add back any interest expense. Let’s say the company paid $5 billion in interest expense.
3. Add back any taxes paid. Let’s say the company paid $10 billion in taxes.
4. Add back any depreciation and amortization expenses. Let’s say the company had $15 billion in these expenses.
5. Microsoft’s EBITDA is equal to $40 billion + $5 billion + $10 billion + $15 billion = $70 billion.

In this example, Microsoft’s EBITDA is $70 billion. This means that the company made $70 billion in profit from its core business operations, before accounting for expenses like interest, taxes, depreciation, and amortization.

Limitation of EBITDA for a company in finance perspective

Some limitations that investors should be aware of. Some of the main limitations of EBITDA are:

• EBITDA does not include expenses for interest and taxes, which can be significant for some companies. This means that EBITDA can be higher than other measures of profitability, like EBIT and EBT, which do include these expenses. This can make EBITDA a less accurate measure of a company’s true profitability.
• EBITDA also does not include expenses for depreciation and amortization, which can be significant for companies with a lot of long-term assets, like buildings and machinery. This means that EBITDA can be higher than other measures of profitability, like EBIT and EBT, which do include these expenses. This can make EBITDA a less accurate measure of a company’s true profitability.
• EBITDA can be influenced by a company’s choice of accounting methods. For example, a company can choose to use different methods for calculating depreciation and amortization, which can affect its EBITDA. This can make it difficult to compare the EBITDA of different companies, as they may be using different accounting methods.
• EBITDA does not take into account a company’s capital structure, or the mix of debt and equity that it uses to finance its operations. This means that EBITDA does not reflect the potential risks and costs associated with a company’s use of debt. This can make EBITDA a less useful measure of a company’s long-term viability.

Overall, while EBITDA is a widely used measure of a company’s profitability, it has some limitations that investors should be aware of. It is important to use EBITDA in combination with other measures of profitability, like EBIT and EBT, to get a more complete picture of a company’s financial performance.