EBITDA – Earnings before Interest, Taxes, Depreciation and Amortisation

What is EBITDA?

EBITDA stands for Earnings before Interest, Taxes, Depreciation and Amortisation and is a measure of a company’s income before any impact of accounting or taxation. It is an alternate measure of profitability to net income and helps loosely measure a company’s cash flow before operational expenses. 

There is some dispute around the accuracy of EBITDA as it might overstate profitability by excluding important expenses like taxes or depreciation. EBITDA is not a metric recognised by the Generally Accepted Accounting Principles (GAAP). 

However, companies still use it as a measure of profitability when reporting finances to investors and stakeholders. 

How to calculate EBITDA?

EBITDA can be calculated with two formulas. 

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

Or 

EBITDA = Operating Income + Depreciation + Amortisation

All the figures required to calculate EBITDA can be found in the company’s statements of accounts, and can be easily calculated if the company does not already provide it. 

Example of EBITDA Calculation

Here is an example of calculating EBITDA. Company ABC reported the following figures:

First, calculate the net income from these figures:

Net Income = Revenue − COGS − Operating Expenses − Depreciation − Interest − Taxes 

Net Income (in crores)  = 1,000 − 600 − 150 – 30 − 20 − 40 = ₹160 crores

Finally, add back interest, taxes, depreciation and amortisation to get the EBITDA value

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

EBITDA (in crores) = ₹160 + ₹20 + ₹40 + ₹30 + ₹10 = ₹260 crores 

Thus, the EBITDA for Company ABC is ₹260 crores. 

EBITDA as a financial metric

EBITDA isolates operational performance by disregarding external factors, making it an effective tool for assessing how efficiently a company runs its business. Additionally, EBITDA can also be used to compare the financial performance of companies in industries with differing capital or taxation structures. 

However, since it fails to account for critical spending on assets which is needed to sustain operations, EBITDA is seen by many investors and accountants as an overestimation of profitability. 

While it is useful for understanding profitability before external factors, it should not be used in isolation. Investors and analysts should pair it with other metrics, such as Free Cash Flow (FCF) or Net Income, to get a comprehensive view of a company’s financial health.

Advantages of EBITDA

• Focuses on operational performance rather than accounting practices
• EBITDA offers a standardised measure for valuing companies
• Relevant for asset-heavy industries like manufacturing or capital-light industries like software
• Helps compare companies within and across industries 
• EBITDA is a good measure of a business’s core cash-generating potential
• It is also used in valuation of companies during mergers or acquisitions

Drawbacks of EBITDA

• EBITDA ignores all capital expenditures, which can end up overstating profitability, particularly in asset-heavy industries like manufacturing or telecommunications, where ongoing capital investments are substantial
• Excludes tax, interest and depreciation expenses, which are critical and unavoidable expenses
• Companies with significant debt obligations can appear more profitable using EBITDA, as it ignores the burden of debt servicing costs (interest payments)
• EBITDA is a non-GAAP metric, meaning there is no universal standard for its calculation

EBITDA vs Operating Cash Flow

EBITDA in company valuation

EBITDA helps investors and analysts estimate a company’s value by removing factors like financing, tax policies, and non-cash expenses, making comparisons across businesses easier. 

The Enterprise Value (EV) to EBITDA Multiple is commonly used as a measure of a company’s value. This multiple shows how much investors are willing to pay for each unit of EBITDA. A company’s Enterprise Value (EV) can be calculated as the sum of its market cap and net debt. 

Enterprise Value (EV) = EBITDA × EV/EBITDA Multiple

How to improve EBITDA

EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization) is a critical metric for assessing a company’s financial performance and profitability. Improving EBITDA requires a strategic focus on increasing revenue, optimizing costs, and enhancing operational efficiency. Here are some effective ways to improve EBITDA:

Increase Revenue Streams

Diversifying revenue sources or expanding into new markets can drive growth. Additionally, upselling and cross-selling to existing customers can enhance profitability without significant incremental costs.

Optimize Operating Costs

Reducing unnecessary expenses, renegotiating vendor contracts, and streamlining supply chains are effective ways to improve operational efficiency and boost EBITDA.

Focus on Productivity

Investing in employee training and technology can enhance productivity, enabling the business to achieve more with fewer resources.

Automate Financial Operations

Automation reduces errors, minimizes manual intervention, and accelerates financial processes like invoice approvals, reconciliation, and cash flow management. Solutions like RazorpayX Business Banking help businesses streamline financial operations by providing features such as automated payouts, real-time tracking of transactions, and smart tools for payroll and expense management. This not only saves time but also reduces operational costs, directly impacting EBITDA positively.

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Review Pricing Strategies

Periodically revisiting pricing models can help businesses capture more value. Adjusting prices to reflect market demand or cost changes can significantly enhance margins.

By focusing on these strategies, businesses can improve their EBITDA and build a more resilient, profitable organisation.

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