What is EBITDA?
EBITDA stands for earnings before interest taxes, depreciation and amortization. It is a measure of an organization’s operating performance.
This calculation provides an important evaluation of a company’s core operations prior to capital structure, leverage and other non-cash items such as depreciation. Analysts use EBITDA to assess if a company is not profitable after evaluating other measures, such as free cash flow and operating income.
How to calculate EBITDA
EBITDA = Operating Profit + Depreciation Expense + Amortization Expense
(The equation above excludes interest and taxes.
Analysts can focus on core business by excluding these elements from earnings. Depending on how financing was obtained, companies in the same industry may have different interest costs.
The EBITDA calculation does not include the company’s financial structure, which is not part of its core operations. This makes it easier and more efficient to target the core operations of the company.
Companies can pay different taxes to be able to operate in certain countries or regions. Tax expenses can have a significant impact on your bottom line. However, by removing them from EBITDA, you bring the profitability of each business into sharper focus.
What is Depreciation,and Amortization
The past decisions of company management are what determine depreciation and amortization. This is irrelevant when assessing the current health of the company’s operation. The depreciation of tangible fixed assets (e.g. buildings, vehicles) is a function of company management decisions. Despite being inevitable due to wear and tear, these calculations can sometimes be inconsistent depending upon the method used. This is also true for amortization expenses such as patents which are intangible assets.
EBITDA should not be used without caution. Some investors believe that an investor’s operating acumen doesn’t matter if the rest is poorly structured. This is similar to a costly house built on sand. It is less valuable if it has a fatal flaw.