What is Earnings Before Interest Taxes Depreciation and Amortization?

EBITDA is simply a acronym for the words Earnings before interest, tax, depreciation, and amortization. Simply put, is the measurement of company's operating profitability. It excludes these non-operating expenses to give you a better picture of your company's actual performance.

What is the EBITDA Formula? 

Here is the formula. EBITDA = Net Income + Interest (expense) + Depreciation + Amortization (all for the fiscal reporting period). 

Let's take a look at the key factors that make up EBITDA. 

How Does EBITDA Work? 

Earnings consist of revenue minus expenses (not including interest expense, depreciation expense, and amortization expense).

Why Remove Interest from the EBITDA Formula? 

Taking interest payments out of the net income calculation is the best way to neutralize how the cost of debt can skew earnings and its affect on taxes owed. 

If a company relies heavily on debt, such as when the company is fully leveraged as party of a leveraged buyout, it better reflects company performance to show the net earnings without the heavy interest expense. 

Why Remove Taxes from the EBITDA Formula? 

The amount a company pays in taxes in a given year can easily distort the performance numbers. Also, taxes do not always raise the EBITDA number, as many companies do not report a profit for tax purposes. This is particularly true when a company has loss carry forwards or excessive debt (the interest payments offsets profitability). 

Why Remove Depreciation from the EBITDA Formula? 

Depreciation is an expense that generally does not match with the outlay of capital to acquire it. As such, depreciation expenses do not affect the actual cash on hand. Rather, it is an accounting measure to show a company's asset is decreasing. 

Why Remove Amortization from the EBITDA Formula? 

Because the R&D payments were made at an earlier time, amortization does not affect available cash.

Amortization is only taken as an expense to the extent of the company's basis in the intangible asset. This is normal research and development costs (R&D). Once the R&D cost is fully amortized when it has all been treated as an expense. 

How is EBITDA Used? 

EBITDA is commonly used when comparing high-debt companies. 

When a company does not have very impressive net income, it looks better to filter out the effects of debt payments (interest) and the non-cash affects of depreciation of tangible assets and the amortization of intangible ones. It takes the sting out of an otherwise low profitability number.

Example of Calculating EBITDA

Example Lets assume ABC Company EBT ($450,000), Interest Expense ($60,000), Depreciation ($85,000) and Amortization ($35,000) and then use the formula above: 

EBITDA = $450,000 + $60,000 + $85,000 + $35,000 = $630,000 

In the example, the we go ahead and add taxes back to earnings.