EBITDA is an accounting indicator of the profitability of a company. It is calculated as income less expenses, excluding financial expenses (taxes, interests, depreciations and amortizations of the company).
The name EBITDA stands for Earnings before interest, taxes, depreciation and amortization, that is, the profit before interest, taxes, depreciation and amortization.
EBITDA = Revenue - costs of goods sold - general administration costs
EBITDA is frequently used to assess the ability to generate profits of a company considering only its productive activity, since it indicates the result obtained by the direct exploitation of the business. Since it doesn't include all of your business expenses, it more clearly shows how much money you have left to pay off your debts. Often it receives criticism, because it is a ratio that can be misleading and that if it is confused with the cash flow it can be very dangerous in order to assess the health of a company.
Advantages of using EBITDA
Despite the criticism, it has many points in favor, such as:
- It serves as a shortcut to estimate the available cash flow of a company, that is, it tells us the money that a company has left to pay its debts after subtracting its most important expenses. It is a ratio that tells us at a glance the solvency of a company and tells us whether or not it can pay its debt. EBITDA is the basis for calculating the debt coverage ratio.
- It is very useful for comparing companies, comparing historical company data, and comparing with industry data. Because EBITDA shows us information that is not affected by financial leverage, taxes or amortization costs, which in certain companies are very high. Eliminating these items from your calculation makes it very easy to compare the financial health of various companies.
One of the reasons EBITDA has become so popular, to the point where many languages use the term English (including Spanish), is because it shows the company's earnings without deducting certain expenses. Therefore, it gives the impression that profits are higher, showing more profits than the operating result shows. And that the entrepreneurs like a lot.
Considerations when analyzing EBITDA
To use EBITDA well it is very important:
- Don't substitute it for cash flow.
- Know that the earnings it shows are not counting some expenses, so they seem higher.
- It is used to buy companies at a glance, but if you want to do a more in-depth analysis, you have to take into account the quality of the earnings.
EBITDA in the income statement
In the income statement, EBITDA is located just above gross operating profit, which is the same as EBITDA but discounting provisions and amortizations. To see it more clearly, let's see the following example:
|Net income or sales||100|
|- Direct costs of the goods sold||-50|
|- General, personnel and administrative expenses||-20|
|- Amortization expenses and provisions||-5|
|Earnings before interest and taxes (BAIT) or EBIT||25|
|+ Extraordinary income||1|
|- Extraordinary expenses||-2|
|+ Financial income||2|
|- Financial expenses||-3|
|Profit Before Tax (BAT) or EBT||23|
|- Corporation tax||7|
|NET PROFIT OR RESULT OF THE YEAR||16|
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