Introduction:
Earnings Before Interest, Taxes, Depreciation, and Amortization is what is fully referred to as EBITDA. It is an alternative way of calculating net income profitability. It eliminates the capital structure-dependent non-cash depreciation, amortization expense, taxes, and debt costs.
The cash profit generated by the company's operations is attempted to be displayed in the earnings before interest, taxes, depreciation, and amortization. Here is everything about EBITDA in detail.
What is EBITDA
A substitute metric for net income as a measure of profitability is EBITDA, or earnings before interest, taxes, depreciation, and amortization. To approximate the cash profit generated by the company's operations, EBITDA includes depreciation and amortization in addition to taxes and debt payment costs.
According to generally accepted accounting principles, EBITDA is not a recognized metric (GAAP). A few publicly traded companies include adjusted EBITDA figures in their quarterly results, which typically exclude additional expenses like stock-based compensation.
How is EBITDA Calculated?
It is primarily computed by deducting from net income the costs incurred by the business other than interest, taxes, depreciation, and amortization.
There are two formulas that can be used for the same:
EBITDA = Net Profit + interest + Taxes + Depreciation + Amortization
EBITDA = Operating Income + Depreciation + Amortization
Businesses use these formulas to efficiently determine a particular facet of their operations. Since it is a non-GAAP calculation, the user can choose which expenses to include in the net income.
For example, an investor can choose to exclude only taxes and depreciation in order to examine the potential impact of debt on a company's financial standing.
Example
Assume that ABC Manufacturing Company has the data below, which was taken from the annual earnings report for 2022:
- Net income = Rs. 10,000,000
- Depreciation and amortization = Rs. 3,000,000
- Taxes = Rs. 5,000,000
- Interest expense = Rs, 5,000,000
- Operating income = Rs. 20,000,000
First Formula:
EBITDA = Net Profit + Interest + Taxes + Depreciation + Amortization
EBITDA = Rs 10,000,000 + Rs. 5,000,000 + Rs. 5,000,000 + Rs. 3,000,000 = Rs. 23,000,000
Second Formula:
EBITDA = Operating Income + Depreciation + Amortization
EBITDA = Rs. 20,000,000 + Rs. 3,000,000 = Rs. 23,000,000
EBITDA vs Gross Profit
While both EBITDA and gross profit measure a company's profitability, they do so in different ways. Earnings Before Interest, Taxes, Depreciation, and Amortization, or EBITDA, measures operational effectiveness by taking into account expenses that are under the company's direct control. It excludes external factors. Gross profit, on the other hand, measures how well a business uses its labor by comparing the difference between production costs and sales revenue.
Formulas for EBITDA and Gross Profits
These formulas can be used to determine the correct values if you want to calculate a company's gross profits or EBITDA. It is useful to review the accounting documents provided by the company before starting your calculations. A crucial step in ensuring the accuracy of your results is to make sure you have access to the most recent data. The following are the EBITDA and gross profit formulas, along with usage guidelines:
Formula for EBITDA
EBITDA = OI + Depreciation + Amortization
This formula uses operating income (OI) to represent a company's earnings after operating costs are deducted. Operating costs can involve many different factors, so it is important to look up all the pertinent values in the accounting books before calculating a company's EBITDA. Prior to starting your analysis, it can be a good idea to look over the company's books as you can find the values for asset amortization and depreciation on the balance sheet.
Formula for Gross Profits
Gross profit = revenue − COGS
Revenue is the total amount a business makes from selling the product, while COGS stands for cost of goods sold. You can determine how much value the company creates from sales by deducting COGS from total revenue. If you want to compare different companies that sell similar products to determine which ones have the best profit margins, this formula can be helpful.
How to Calculate EBITDA for Gross Profit
You need to consider more than just the gross profit in order to calculate EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization) based on profit. Here's a quick guide you can use:
Begin with Gross Profit: Calculate the profit by subtracting the Cost of Goods Sold (COGS) from Revenue using this formula;
Gross Profit = Revenue. COGS
Determine Operating Expenses: Make a list of all the operating costs the business has to pay. These costs include things like rent, utilities, employee salaries, marketing expenses, and any other costs that are directly related to operating the business.
Compute Operating Income (OI): Deduct operating expenses from the profit to obtain the operating income (OI). The formula is;
OI = Gross Profit. Operating Expenses
Include Depreciation and Amortization: Refer to the depreciation and amortization values in the company's reports. These figures illustrate both the dispersion of intangible asset costs and the gradual loss of value of tangible assets.
Combine Elements for EBITDA: Add depreciation and amortization to the operating income (OI) calculated in step 3. The EBITDA formula is;
EBITDA = OI + Depreciation + Amortization
By following these steps and using information from the company's records, you can determine EBITDA starting from gross profit.