Before starting how to calculate EBITDA, let us see what it is. EBITDA is the Earnings Before Interest, Taxes, Depreciation and Amortization. This is a measure of a corporation’s financial performance. It indicates a corporation’s financial performance by calculating earnings from its core business operations, without considering the effects of capital structure, tax rates, depreciation and amortization policies.
EBITDA is an approximation for cash flow. It ignores many factors that affect the true cash flow, such as debt payments. EBITDA could be helpful for evaluating corporations in the same industry with widely different capital structures, tax rates, and depreciation and amortization policies.
How to Calculate EBITDA? EBITDA Calculation Formula:
EBITDA = Revenue – Expenses (excluding tax, interest, depreciation, amortization)
EBITDA = EBIT +Depreciation+ Amortization ( where, EBIT = Revenue – Expenses)
Advantages And Disadvantages Of Using EBITDA
Advantages Of Using EBITDA:
Price to EBITDA is similar in concept to the Price to Earnings Ratio or PE Ratio. The EV / EBITDA ratio is more useful because, unlike the P/E ratio, it is capital structure neutral. The price-to-EBITDA ratio has the equivalent advantages as the Price-to-EBITDA ratio. But, by adding back depreciation and amortization to EBIT, it rids the calculation of an accounting measurement that can fluctuate over companies firms and for a given company. It thus can make companies more comparable. EBITDA can indicate how attractive a leveraged buyout candidate the company would be.
Disadvantages Of Using EBITDA:
This ratio suffers from the same disadvantages as the Price-to-EBIT ratio. Additionally, it ignores the fact that depreciation and amortization are real costs. Factories depreciate its machineries, likewise labor costs; copyrights and patents expire over time. Goodwill on a purchase of another company is a cost of the purchase that has to be amortized against the benefits (income) from the purchase, just as depreciation amortizes the cost of physical assets acquired.
The accounting measures of these economic costs might be doubtful, but cannot be ignored. So, adding back depreciation and amortization may shrink comparability.