EBITDA: Overview, definition, and example
What is EBITDA?
EBITDA stands for earnings before interest, taxes, depreciation, and amortization. It is a financial metric used to assess a company’s operating performance by looking at its profitability from core business activities, excluding the effects of financing decisions, tax strategies, and non-cash accounting items like depreciation and amortization. EBITDA is often used by businesses, investors, and analysts to evaluate a company’s financial health and ability to generate cash from operations, independent of its capital structure and tax situation.
For example, if a company earns $1 million in revenue but has $200,000 in expenses (excluding interest, taxes, depreciation, and amortization), its EBITDA would be $800,000.
Why is EBITDA important?
EBITDA is important because it provides a clearer picture of a company's operational performance by focusing on the money made from its core business activities, excluding external factors like financing costs or tax strategies. It helps business owners and investors understand how much cash a company is generating before non-operating factors are taken into account. EBITDA is often used for comparing companies within the same industry, as it provides a standardized measure of profitability that excludes different capital structures and accounting practices.
For SMBs, EBITDA is an essential tool for understanding how efficiently the company is operating and whether it has the financial strength to grow or pay off debt.
Understanding EBITDA through an example
Imagine your business generates $500,000 in revenue and incurs $300,000 in operating expenses, including wages, rent, and utilities. However, the company also has significant interest payments on debt ($50,000) and is subject to depreciation and amortization charges of $20,000. To calculate EBITDA, you would exclude the interest, taxes, depreciation, and amortization from the equation.
Here’s the breakdown:
- Revenue: $500,000
- Operating Expenses (excluding interest, taxes, depreciation, and amortization): $300,000
- EBITDA = Revenue - Operating Expenses = $500,000 - $300,000 = $200,000
This gives you a clearer view of how much cash the business generates from its operations, without considering how it’s financed or the effects of non-cash accounting items.
An example of EBITDA in action
Here’s how EBITDA might be referenced in a business analysis or financial report:
“The company reported an EBITDA of $500,000 for the fiscal year, reflecting strong operational performance and a focus on increasing revenue while keeping costs in check. This EBITDA figure excludes interest payments, taxes, and non-cash depreciation expenses.”
Conclusion
EBITDA is a useful financial metric for assessing a company’s profitability from its core operations, excluding non-operating factors like financing and accounting practices. It helps business owners, investors, and analysts understand the company’s ability to generate cash and operate efficiently. For SMBs, EBITDA provides valuable insight into the health of the business and is a key metric for comparing performance, making decisions about expansion, or evaluating investment opportunities.
This article contains general legal information and does not contain legal advice. Cobrief is not a law firm or a substitute for an attorney or law firm. The law is complex and changes often. For legal advice, please ask a lawyer.