EBITDA is short for earnings before interest, taxes, depreciation, and amortisation. It’s a measure of company’s financial performance and it’s used as alternative to cashflow and net income. EBITDA is variation of company’s EBIT number by adjusting for appreciation and depreciation. Its used to measure company performances without taking into account its capital structure. It focus on business ability to generate profits form its operations without taking into account the impact of the company capital structure.
As the name suggests the EBITDA formula is calculated by simply adding the interest, taxes, depreciation and amortisation back to the net income:
EBITDA = Net Income + Interest + Taxes + Depreciation + Amortisation
The depreciation and amortisation numbers can be found on the company cash flow statements
The main porpoise of using EBITDA instead of EBIT and net income is that EBITDA allows investors to compare businesses from different industries with different capital structures and with different tax rates in a more levelled way. It does this by excluding a lot of the costs that are associated with the way company is operated and structured. Interests is excluded to adjust for the interest expenses and different levels for debt that the different businesses might have. Taxes are excluded to adjust for the different tax rates that businesses might pay based on different tax rules. Since depreciation and amortisation are no cash expenses and they are expenses that the company has done historically and they might not be part of the current operating performance, they are added back to the EBITDA number. Although useful EBITDA has its limitation that the investors should keep in mind. Mainly because it is showing earnings number that presents image of the company as if it doesn’t have to pay interest or taxes, as well as if assets are never lost their natural value over time (no depreciation or Capital Expenditures deducted).