What is EBITDA? How is it calculated? What is it for?

In the beautiful Castilian language we usually translate a few terms in English a little in our own way. Against prognosis, in the case of EBITDA and despite the difficulty to read it that implies the excess of consonants, we have remained with the acronym in English. That’s how we are.

The EBITDA is the profit of a company obtained before subtracting the financial expenses, answering the initials to the English Earnings Before Interest, Taxes, Depreciation, and Amortization. And what are those financial expenses that are not deducted for calculation? Well, three:

  • Amortization and depreciation
  • Debt interest
  • Taxes

Do you find it messy? Do not worry, we have prepared an explanation for dummies.

Imagine the day of your wedding. All the guests have given you a gift and you have a lot of money, – we are rich, honey -, you could tell your partner, but the reality is very different. That money is not your benefit, hence you have to subtract all expenses until, in the end, with everything paid, you have a little left to go on vacation.

How is it calculated and differences between EBIT and EBITDA

To explain how to calculate the EBITDA we will first remove a couple of letters until we have EBIT. The EBIT ( Earning Before Interest and Taxes ) is the gross profit or operating income , that is, the profit before deducting taxes and interest . This is the formula:

EBIT = Sales – Costs – Operating expenses

To calculate the EBITDA, we must add to the EBIT the expenses and provisions of the company corresponding to depreciation and amortization. The formula would look like this:

EBITDA = EBIT + depreciation expenses + amortization expenses

What we have left is the pure result of the company, a figure that indicates its productive force but, eye, does not take into account the financial costs involved in that ability to generate income. Therefore, the EBITDA, by itself, does not say anything about the true financial situation of the company .

– Well, that indicator is useless, right? -, you will be thinking. Relax, there is more.

What is EBITDA for?

The first question that arises once you understand what it is, is always the same, what is it used for in EBITDA? Here are some ideas:

  • Excludes randomness in the provisioning : the criteria may be different in each company , which vitiates the comparison between them.
  • Cancel the impact of taxes on the results : in different countries or sectors tax burdens are different.

In summary, the EBITDA allows to objectively analyze the productive capacity of a company and compare companies that operate under different circumstances and environments . Saving distances, it is an opportunity to compare pears with apples. Do you start to see the utility?

How is it interpreted?

The most important fact that you have to take into account when assessing whether an EBITDA is positive or negative, in terms of quality, not numerical, is that it does not consider the interest on the debt .

This means that if a company contracts a huge liability to finance its growth, it will sell more and the EBITDA will be very high; However, this does not have to translate into a positive final result. This means that the EBITDA does not reflect the financial reality of a company , so it is common to use it in comparison with other indicators.

Have we shed some light on this important financial indicator? Do you have any questions to solve?