What Is EBITDA? Definition and Formula

EBITDA stands for earnings before interest, taxes, depreciation, and amortization. Finance professionals use EBITDA, calculated from details reported in annual financial statements, to determine a company’s profitability. Essentially, EBITDA looks at how much money a company makes before expensing taxes and interest without considering the depreciation of assets.

EBITDA Definition

EBITDA is a measure of profitability like revenue or net income. Using EBITDA removes the variables of depreciation, amortization, and financing by adding them back into the company’s net income (or earnings). By removing these variables, the focus is shifted to the company’s ability to generate cash flows, regardless of how they choose to finance their business, how high their tax rate is, or how quickly their assets lose value. 

Additionally, EBITDA can help finance professionals compare companies in states with different tax rates. Taxes are generally out of a company’s control, so theoretically, taxes do not affect a company’s actual profitability. 

However, some finance professionals and companies don’t use EBITDA at all, preferring to rely on other profitability metrics, like profit margins and the company’s performance history.

Who Uses EBITDA?

Many careers in finance touch upon EBITDA. For example, accountants may need to calculate their client’s EBITDA for financial statements, especially income statements. Additionally, investment bankers and investors often use EBITDA to compare two companies or investment options. 

>>MORE: Studying finance? Check out some of the best jobs for finance majors. 

How to Calculate EBITDA 

You can use a few different formulas to calculate a company’s EBITDA. 

Formula 1

EBITDA = Net Income + Interest + Taxes + Depreciation + Amortization

Formula 2

EBITDA = Operating Income + Depreciation + Amortization

Both formulas are doing the same thing: figuring out what the company’s earnings would be if taxes, interest, amortization, and depreciation were not taken into account. Formula 2 relies on a close relative of EBITDA called EBIT (earnings before interest and taxes), which is equal to a company’s operating income.

Components of EBITDA 

Earnings

A company’s earnings, or net income, is how much the company makes in a given time frame, usually a quarter or year.

Interest

Interest expenses are the cost of having debt. Most forms of debt or financing come with interest on top of the principal payment (how much you need to pay monthly or annually towards the original loan).

Taxes

A company’s total taxes include local, state and federal taxes for things like income and property.

Depreciation and Amortization

Depreciation and amortization represent the gradual decrease in value of assets over time and writing off the asset’s initial cost. Typically, tangible assets, like machinery or buildings, depreciate in value, while amortization applies to intangible assets, like copyrights or patents. An asset is discounted because it will become less valuable as it ages.

Example Calculation

Let’s imagine an auto-parts manufacturing company with the following information pulled from their 2022 annual earnings report: 

• Net income: $10,000,000
• Depreciation and amortization: $3,000,000
• Taxes: $5,000,000
• Interest expense: $5,000,000
• Operating income: $20,000,000

Using the first formula for EBITDA, we have:

EBITDA = $10,000,000 (net income) + $5,000,000 (interest) + $5,000,000 (taxes) + $3,000,000 (depreciation and amortization)

So, the company’s EBITDA based on this formula would be: $23,000,000. 

With the second EBITDA formula, we have: 

EBITDA = $20,000,000 (operating income) + $3,000,000 (depreciation and amortization)

With this formula, we still have the same result. The company’s EBITDA is: $23,000,000.

Drawbacks of EBITDA

EBITDA has several fundamental flaws. First, it can be misleading. Suppose a company has excessive debt and is paying a lot in interest every year. Considering this metric on its own will make the company seem more profitable than it actually is. 

Additionally, EBITDA doesn’t account for expirable assets, like copyrights and patents, or assets that lose value over time, such as machines or vehicles. In fact, EBITDA ignores capital expenditures as a whole, a primary concern of Warren Buffet, CEO of Berkshire Hathaway. 

For accountants, a core issue with EBITDA is that it isn’t a part of the U.S. generally accepted accounting principles (GAAP). This means it isn’t standardized, and the math can differ from company to company. 

Showing You Understand EBITDA on Your Resume

If you have prior work or internship experience in investment banking, mergers and acquisitions, accounting, or a related finance field, your resume is an excellent place to include your professional experience: 

• You can list your skills in calculating profitability metrics (such as EBITDA and profit margins) in the skills section of your resume. 
• You can use the description of your work or internship experience as a space to give concrete professional examples. For instance, you could mention if you completed a comparable company analysis on two companies, using EBITDA as a key metric. 

If you don’t have relevant work or internship experience but have used it outside of the professional space, your cover letter is a great space to talk about that. For example, you could discuss if you calculated EBITDA for a friend or family member’s small business or if you used it yourself when analyzing potential investment opportunities.

Related Skills for Finance Careers 

EBITDA is a skill used in a variety of finance careers. Other essential skills for anyone interested in finance include: 

• Understanding the fundamentals of technical analysis
• Knowing how companies go from private to public (through IPOs and SPACs) 
• The ability to read and understand stock charts 
• Having strong analytical skills

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