What is Adjusted EBITDA (Why Does it Matter?)

July 28, 2022

What is Adjusted EBITDA (Why Does it Matter?)

Adjusted EBITDA is a metric used by public companies and private businesses to determine their profitability. In this article, we're going to break down what Adjusted EBITDA is and why it's important to learn. We’ll also go over EBITDA adjustments, and how to calculate adjusted EBITDA. Let’s get right into it.

What does adjusted EBITDA mean?

Adjusted EBITDA is a financial metric used by the company to measure its performance. It can be calculated as the company's earnings before interest, tax, depreciation and amortization (EBITDA), which reflects the company's operating performance, adjusted for certain non-operating expenses such as debt extinguishment costs, non-cash stock compensation expense, legal settlements and other one-time or unusual items.

Why is adjusted EBITDA important?

The adjusted EBITDA margin is a key metric to measure the operating performance of a company. It measures the percentage of revenue that a company generates after deducting its expenses, thus eliminating the impact of fixed costs and other factors. The main benefit of this metric is that it allows you to compare companies on an apples-to-apples basis, even if they have varying capital structures or accounting practices.

How do you calculate adjusted EBITDA?

When a company reports its earnings, it must separately report every expense that has been incurred during the period. This can include costs related to rent, utilities, employee compensation, interest payments on debt and many other items.

Adjusted EBITDA excludes these expenses so you can get a clearer picture of how much profit the business is actually earning after all of its direct costs have been taken out.

The formula for calculating adjusted EBITDA is as follows:

Adjusted EBITDA = (Revenue - Cost of Goods Sold) - Selling, General & Administrative Expenses + Depreciation + Amortization + Other Operating Income/Expense Items - Interest Expense

Is adjusted EBITDA same as net income?

Net Income and Adjusted EBITDA are two different measures of a company's financial performance.

Net Income (or profit) is what remains after all expenses, interest, taxes and depreciation have been accounted for. It is calculated as Revenue minus Expenses minus Interest Expense minus Taxes Paid.

Adjusted EBITDA (Earnings Before Interest Taxes Depreciation and Amortization) adds back some of the expenses that are included in Net Income but not considered to be part of ongoing operations. For example, it adds back depreciation expense because it does not represent an actual cash expense for the company.

The difference between Net Income and Adjusted EBITDA is that Net Income includes interest expense while adjusted EBITDA does not include interest expense.

Why do companies use adjusted EBITDA?

Adjusted EBITDA is used by companies to paint a more accurate picture of their financial performance than net income alone. The reason companies use adjusted EBITDA is because it allows them to remove items that should not necessarily be included in their calculation of profitability.

For example, interest expense can be thought of as an investment cost rather than an expense. Therefore, it should not be included in the calculation of profitability since it does not represent actual cash outflow from operations.

Likewise, depreciation expense may not represent an actual cash outflow from operations because the asset being depreciated may have been purchased many years ago and never actually consumed any cash.

What is a good adjusted EBITDA margin?

Having a good adjusted EBITDA margin is important because it helps investors understand how much money the company makes on each dollar of sales. This information can be useful when comparing companies in an industry that have different costs of operation but sell similar products.

A good rule-of-thumb is that a company should have an adjusted EBITDA margin that is at least 10 percent higher than its competitors' margins. For example, if Company A has an adjusted EBITDA margin of 15 percent, then Company B should have an adjusted EBITDA margin at least 25 percent.

Summary

EBITDA stands for earnings before interest, taxes, depreciation, and amortization. It's simply the company's pre-tax income. Adjusted EBITDA is when you add back non-cash items (depreciation, amortization, changes in inventory) to get a sense of how much the company is actually making.

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