Guide to EBITDA Calculation

Mike ZaccardiUpdated January 9, 2023

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Earnings before interest, taxes, depreciation, and amortization (EBITDA) is often used as an alternative to net income to measure a business’s financial performance. By eliminating the effects of financing and accounting decisions, EBITDA is designed to zero in on a firm's ability to generate cash flow for its owners.Here’s a closer look at EBITDA, including how it works, how it's calculated, and what this performance metric can tell you (and others) about your business.

What Is EBITDA?

EBITDA (earnings before interest, taxes, depreciation, and amortization) is an earnings metric that is sometimes used instead of net income to gauge a company’s profitability. EBITDA tells you the earnings that a business has generated prior to any debt interest expenses, tax payments, and non-cash depreciation/amortization costs.EBITDA doesn’t factor these values in because they are outside of management’s operational control. By adding these values back to net income, many analysts believe that EBITDA is a better measure of company performance since it shows earnings before the influence of accounting and financial deductions.EBITDA does not reflect a company’s actual cash flow, and is a non-GAAP metric, meaning it is not recognized by the generally accepted accounting principles. Because depreciation is not captured in EBITDA (it's added back to net income in the EBITDA calculation), this metric may lead to distortions for companies with a significant amount of fixed assets.Recommended: How to Calculate Cash Flow

What Is It Used for?

Business owners will often calculate EBITDA on a monthly or quarterly basis to review their company’s performance. They might also calculate EBITDA for potential buyers if they’re anticipating a sale. Investors will often use EBITDA to compare a company’s performance to its competitors. It enables them to look at companies based solely on their operations, excluding the impact of taxes, amounts of debt, and the cost of their capital investments. This allows for a more apples-to-apples comparison. Lenders may also look at EBITDA when determining whether or not a business will be able to repay a loan. A firm with a strong history of consistent and growing EBITDA is more likely to be offered favorable small business loan rates. Recommended: Applying for & Getting Small Business Loans

EBITDA Formula

The question remains, how do you calculate EBITDA? There are actually two EBITDA calculation formulas — one uses net income as the starting point, while the other uses operating income as the starting point.

Net Income

The formula for calculating EBITDA using net income is:EBITDA = Net Income + Taxes + Interest Expense + Depreciation & AmortizationWith this formula, you start with net income. Net income is calculated by subtracting all expenses from total revenue. This includes everything from the cost of goods sold (COGS) to interest and tax payments. In order to calculate EBITDA, you need to add back interest and tax line items. In addition, you need to add back depreciation and amortization expenses.

Operating Income

The formula for calculating EBITDA using operating income is:EBITDA = Operating Income + Depreciation & AmortizationOperating income is, as the name suggests, the money a business makes from its operations. It’s the amount of money that remains after operating expenses and COGS have been deducted from revenue.Operating income, or profit, is found in the middle of the income statement. Tax and interest expenses are already excluded, so you just need to add depreciation and amortization. The two EBITDA calculations can potentially yield different results as net income includes line items that might not be included in operating income, such as non-operating income or one-time expenses.

Breaking Down the EBITDA Formula

Here’s a more in-depth look at each part of the EBITDA calculation and why it’s included in the formula.

Net Income

Net income is profit as opposed to revenue. Also known as net profit, it’s the amount of money a company makes over a period of time after it accounts for all of its expenses incurred over that same period. It is the “bottom line” on the income statement and shows what’s left after subtracting all expenses from total revenue, including COGS, operating expenses, non-operating expenses, taxes, interest, and all other expenses.Recommended: EBITDA vs Revenue

Interest

Interest expense is the cost of borrowing money for business activities, such as taking out various kinds of business loans. Because how a business raises capital can vary widely, interest payments can also vary from company to company. For that reason, interest is removed from consideration here. Variations in how a company chooses to finance its activities (known as its capital structure) makes comparing business operations difficult.

Taxes

Taxes for EBITDA are the taxes paid by businesses, including income taxes, excise taxes, and employment taxes. Each locality has different tax laws, which means that tax payments can vary widely from one company to another. Similar to interest, companies have little control over how much they’ll owe. Since tax obligations aren’t uniform, they’re taken out of consideration in the EBITDA calculation.

Depreciation

Depreciation is the process of spreading out the cost of a tangible asset over the course of its useful life. While depreciation does cost a business money (as machinery and vehicles do wear out), it’s a non-cash expense that depends on past investments the company has made and not on the current operating performance of the business. Therefore, EBITDA doesn’t factor it in.

Amortization

The key difference between depreciation vs. amortization is that amortization involves the depreciation of intangible items, such as patents or licenses, which also have a limited useful life due to expiration. While amortization is an expense that is reported on a company's financial statements, it isn’t directly related to a business’s core operations, so EBITDA doesn’t factor it in.

Operating Profit

Operating profit – also called operating income – is the result of subtracting a company's operating expenses from gross profit. A business's operating expenses are costs incurred from normal operating activities and include items such as office supplies and utilities. It does not consider interest or tax expenses but does include the non-cash charges of depreciation and amortization, so those must be added back to arrive at EBITDA.Recommended: Debt to EDITDA Ratio Explained

Example of the EBITDA Calculation

Let’s use company ABC as an example of the EBITDA calculation. Company ABC has a net income of $10 million in a year. Also on the income statement are the following items: Interest expense: $500,000 Tax expense: $1,000,000 Depreciation & amortization expenses: $400,000 To find EBITDA using the net income formula, you simply add interest, taxes, and depreciation & amortization expenses back to net income: EBITDA = $10,000,000 + $500,000 + $1,000,000 + $400,000 = $11,900,000 While company ABC’s net income is just $10 million, EBITDA is higher after adding back those costs.

EBITDA Margin

Margin, sometimes called margin of safety, is used in accounting to calculate a company’s sales compared to its profit. EBITDA margin, which looks at EBITDA as a percentage of total revenue, is one of many ways investors evaluate margin of safety. The formula for this ratio is:EBITDA Margin = EBITDA / Total RevenueFor companies that have little debt or depreciation to account for, EBITDA margin can be a helpful metric to keep an eye on, since it breaks down operational profits into a percentage. Like the EBITDA number, EBITDA margin can be used to compare a company’s financial performance to that of others within the industry.The higher the EBITDA margin, the smaller a company’s operating expenses are in relation to their total revenue, which can lead to a more profitable operation.

The Takeaway

EBITDA stands for “earnings before interest, taxes, depreciation, and amortization.” This earnings metric is often used in place of net income to analyze and compare profitability among companies, as it eliminates the effects of financing and accounting decisions. Like all financial metrics, EBITDA is generally best calculated in tandem with other metrics that help business owners and investors understand the whole picture of a business’s health.

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Frequently Asked Questions

What is the formula for calculating EBITDA?

What would be considered a good EBITDA?

What taxes does the EBITDA calculation include?

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About the Author

Mike Zaccardi

Mike Zaccardi, CFA, CMT, is a finance expert and writer specializing in investments, markets, personal finance, and retirement planning. He enjoys putting a narrative to complex financial data and concepts; analyzing stock market sectors, ETFs, economic data, and broad market conditions; and producing snackable content for various audiences.

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