What is the measure of earnings before interest, taxes, depreciation, and amortization (EBITDA)?

In the world of finance and business, companies are rushing to achieve profits and prosperity, but how can investors and analysts evaluate the performance of a particular company apart from the complexities of taxes and costs? This is where the measure of earnings before interest, taxes, depreciation, and amortization, known as EBITDA, comes into play. This measure, which has become a cornerstone of financial analysis, provides a clear and simplified view of the company’s operational efficiency, going beyond the financial complexities to reach the essence of true performance. So let us dive into the depths of this measure to discover how it contributes to building a transparent and accurate picture of companies’ performance in the financial markets. Follow along with us.

What is the measure of EBITDA?

The measure of earnings before interest, taxes, depreciation, and amortization can be abbreviated by the word “EBITDA,”  which in English means (earnings before interest, taxes, depreciation, and amortization. It is worth noting that this measure is a common analytical tool used to evaluate a company’s performance and measure its net income with the aim of determining its profitability.

Many companies include EBITDA results and statistics in their financial reports, especially in quarterly reports. This is done because this measure excludes additional expenses, such as stock compensation, which makes the results clearer regarding core operations.

EBITDA objectives and benefits

The EBITDA measure aims to give the company a clear idea of its cash profits resulting from its business activities by eliminating some non-cash accounting items, such as depreciation and amortization, in addition to tax and interest expenses on debt. Therefore, this provides a clearer picture of the company’s actual operating performance without the effects that may distort the financial results.

Disadvantages of the EBITDA measure

The EBITDA measure is one of the common financial indicators that companies use to evaluate their operating performance. Despite its popularity, it faces many criticisms due to its defects and limitations in providing an accurate and comprehensive picture of the company’s financial situation, as its disadvantages include the following:

Not being approved in accordance with accounting principles

According to Generally Accepted Accounting Principles (GAAP), the EBITDA measure is a non-validated indicator; therefore, this means that the values and information based on it are not allowed to be included in the official financial reports of companies.

This issue is because EBITDA does not take into account all costs and expenses, which makes it inadequate to provide a comprehensive picture of the financial situation.

Non-uniform standards

One of the main disadvantages of the EBITDA measure is the lack of uniform standards for calculating it, as each company adopts a different mechanism for calculating it, which makes comparisons between companies inaccurate. It is worth noting that this discrepancy in calculation leads to large discrepancies in results, which makes it difficult for investors and financial analysts to reliably evaluate the financial performance of companies.

Focus on EBITDA rather than net income.

Many companies prefer to focus on the EBITDA metric rather than net income because it gives them a better assessment of their operating performance. Notably, this preference can be misleading, as EBITDA excludes some important expenses, such as interest, taxes, depreciation, and amortization.

This focus can give a false impression of a company’s financial health, which may lead to ill-informed investment decisions.

Risks of manipulating results

One of the risks that investors should be aware of is that companies use the EBITDA measure to hide their true financial performance. Companies that suddenly announce and confirm EBITDA results after hiding those numbers in the past may be carrying large debts or expenses that exceed capital.

This manipulation could be an attempt to mislead investors about the true financial health of the company.

The difference between ebit and ebitda

The difference between EBITDA (a measure of earnings before interest, taxes, depreciation, and amortization) and EBIT (earnings before interest and taxes) can be known through the following table:

How to Calculate EBITDA

Basic data for calculating EBITDA

To accurately calculate EBITDA, we need four key pieces of information that are typically available in a company’s financial records:

•  interest.
• Taxes.
• amortization.
• Depreciation. 

Data sources

• Interest and taxes: These can be found on the income statement.
• Depreciation and amortization: Its data is usually obtained from the operating profit notes or from the cash flow statement.

EBITDA calculation

It is calculated by adding depreciation and amortization expenses to EBIT, as in the following formula:

• EBITDA Calculation: Operating Earnings + Interest + Taxes + Depreciation.

An example of an EBITDA measure

Suppose we have a company that generates the following revenues:

• Revenues: 80 million Saudi riyals.
• General expenses: 15 million Saudi riyals.
• Cost of goods sold: 35 million Saudi riyals.

Operating profit calculation

• Operating profit = revenues minus overhead expenses minus the cost of goods sold.
• = 80 – 15 – 35 = 30 million Saudi riyals.

Earnings before interest and taxes (EBIT) calculation

If depreciation and amortization costs are 7 million Saudi riyals, then:

• EBIT = operating profit minus depreciation and amortization.
• EBIT calculation = 30 minus 7 = 23 million Saudi riyals.

Calculate income before taxes (EBT).

If the interest is 3 million Saudi riyals, then:

• EBT = EBIT + Interest.
• EBT = 23 minus 3 = 20 million Saudi riyals.

Calculate net income.

If the tax rate is 20%:

• Taxes = income before taxes = 20%.
• 20 * 0.20 = 4 million Saudi riyals.
• Net income = income before taxes minus taxes.
• = 20 minus 4 = 16 million Saudi riyals.
• Calculating EBITDA = net income + interest + taxes + depreciation and amortization.
• = 7 + 4 + 3 + 16 = 30 million Saudi riyals.

It is worth noting that the EBITDA measure reflects the company’s ability to achieve operating profits without being affected by accounting and financing factors, which is 30 million Saudi riyals in this example.

EBITDA measurement model

If you would like to download the EBITDA model, simply click here.

Elements of the EBITDA model

The EBITDA model is an important financial tool used to evaluate a company’s performance by focusing on the profits resulting from its basic operating activity, away from the impact of interest, taxes, and depreciation. The model is based on four main elements, which are:

Operating Earnings

They represent the revenues that the company achieves from its core activity, such as sales of products or the provision of services. These profits are calculated after deducting the direct costs associated with operational activity, such as wages, raw material costs, and administrative and marketing expenses. Thus, operating profits reflect the true performance of the company’s main activity without the influence of non-operating factors.

Taxes

Taxes paid on profits are one of the elements taken into account when calculating EBITDA, and in this model taxes are ignored because the goal is to evaluate operating performance independent of tax liabilities.

Taxes that could affect calculations include income taxes and potential other taxes.

Interest

They represent costs related to debts incurred by the company, such as: interest on loans and debt securities.

In calculating EBITDA, interest is added because the model aims to provide a clear picture of a company’s operating profitability without the effects resulting from financing decisions, in other words: it ignores the effect of interest on operating performance to estimate the effectiveness of business operations.

Depreciation and Amortization

Impairment costs include fixed assets (such as equipment and buildings) and intangible assets (such as patents and licenses).

Depreciation refers to the costs associated with the wear and tear of fixed assets over time, while amortization refers to the costs of consuming intangible assets. These costs are added to operating profits in an EBITDA measure model to evaluate actual performance without the accounting effects of long-term investments.

How to use the EBITDA model

When using the EBITDA model (a measure of earnings before interest, taxes and amortization), it is necessary to understand how it is calculated and analyze its results accurately. The following is a comprehensive explanation of how to use this model in an organized manner:

Collect the necessary financial information

To begin the analysis process, you must obtain the basic financial statements of the company whose performance you wish to evaluate. It is worth noting that this information usually includes:

• Income statements, which display revenues, costs, and expenses in addition to net profit,.
• Financial statements, which include assets, liabilities, and shareholders’ equity,.

This data is usually available in the company’s annual reports or in other official financial documents.

Calculate the EBITDA value.

To calculate EBITDA, you need to collect the following information from the financial statements:

• Operating Income: These are the profits that the company achieves from its core activities and are found in the income statement.
• Interest represents the costs of debt and is also present in the financial statements.
• Taxes: Taxes on profits are calculated from the financial statements.
• Depreciation and amortization: This includes the costs of depreciation of fixed and intangible assets and appears in the financial statements.

Analysis of the results

After calculating the EBITDA measure, you need to analyze the results in different ways, as follows:

• Compare results: compare your EBITDA to the company’s past results, as well as industry or competitor benchmarks.

Understand the context.

Interpreting the EBITDA value requires understanding the full context of the company by:

• Non-recurring factors: Check whether there are non-recurring events that may have affected the results, such as the sale of unusual assets.
• Market and Strategy Changes: Be sure to take market changes or adjustments in strategy into account as they affect EBITDA results.

Use EBITDA with caution.

Although EBITDA is an important indicator of the strength of a company’s operating performance, it should be used with caution by:

• Variation between companies: Interest, taxes, and depreciation costs can vary from company to company, so be sure to take these differences into account.
• Other Factors: EBITDA does not take into account all factors that may affect a company’s performance, such as: changes in cash flow.

The benefit of the Qoyod website regarding EBITDA

The Qoyod accounting website contributes to calculating the earnings before interest, taxes, depreciation and amortization (EBITDA) measure by providing accounting tools and reports that enable companies to accurately monitor and analyze financial performance, as the benefit of using the website lies in the following:

• Providing accurate data: It helps in compiling and analyzing the financial data necessary to calculate EBITDA, providing clear insights into the company’s performance.
• Easy access to reports: Allows users to access detailed, easy-to-use financial reports that facilitate the process of calculating and analyzing EBITDA.
• Performance analysis: It contributes to evaluating the company’s financial performance by providing insights into operating profits without the effects resulting from taxes.
• Decision Assistance: Provides analysis tools that help companies make strategic decisions based on actual financial performance.

Conclusion

It turns out that the EBITDA measure is not just a passing number in corporate reports but rather a window into the health of a company’s financial performance, providing important strategic insights. It is worth noting that understanding this measure helps investors and management make informed decisions and gives them the ability to evaluate actual performance away from non-operational influences.

Ultimately, measuring EBITDA is a vital tool in the world of finance and business, which plays an essential role in sustainable growth and development strategies, so it is preferable to use Qoyod in this regard. It is worth noting that it also provides all its clients with electronic invoice systems as well as point-of-sale systems, warehouses, customers, etc.

Dear reader, after knowing what the EBITDA measure is, try Qoyod now for free for 14 days. It is an affordable accounting program.

   Join our inspiring community! Subscribe to our LinkedIn page and Twitter to be the first to know about the latest articles and updates. An opportunity for learning and development in the world of accounting and finance. Don’t miss out, join us today!