July 8, 2022
How do you judge the health of a company? There’s a lot of different answers to that question, all depending on what “healthy” means for your business. Ability to pay down debt? Simply keeping the doors open? There are so many factors that differ from company to company, even in the same industry, that it can be hard to navigate simple questions about financial health.
When measuring the profitability of a business, it’s important to compare your business to others like it. You also need to take some variables into account in a way that can help to even things out between different companies. This is where calculating EBITDA, or how to use the EBITDA formula comes in.
You may be wondering, what is EBITDA? Is EBITDA the same as net income? The EBITDA formula is used to assess operational performance by taking factors like depreciation and amortisation, interest, and taxes out of the equation. That way, business owners and investors alike have a way of evaluating a company’s profitability without getting thrown off by things like tax rates that differ between states.
EBITDA stands for “Earnings Before Interest, Taxes, Depreciation, and Amortisation.” Things like interest rates and taxation rates can be very different for similar companies, so taking those out of the equation can make it easier to compare businesses to each other.
EBITDA can be a useful metric because:
In simple terms, the EBITDA looks at a company’s internal financial workings before outside forces change the numbers. “Outside forces” could mean lots of equipment that depreciates, or it could mean different capital structures.
There are two different ways to calculate EBITDA. One involves adding your net income, taxes, interest, and depreciation and amortisation together. The other adds operating profit with depreciation and amortisation.
Either formula works and will calculate EBITDA. You can either do so by hand, or by using a template like Liveflow to do the math for you, as well as track EBITDA over time.
But how is EBITDA calculated for dummies? How is EBITDA calculated for small businesses?
There’s a very simple formula you can use to calculate EBITDA. It works the same way for any size of business, and LiveFlow can walk you through it. Whether you use Excel or Google Sheets, LiveFlow’s templates make it easy to calculate EBITDA. Using Liveflow, it’s easy to find and calculate EBITDA at multiple points, from month to month, so you can monitor your businesses’ finances over time.
Using the Liveflow EBITDA calculation template will teach you how to calculate EBITDA from an income statement. When you have the correct numbers, the EBITDA formula will calculate EBITDA for you. First, review your income statement to find your operating income, your interest expense and taxes, and then depreciation and amortisation. Input those numbers in the Liveflow template to see your result.
But it’s very easy to calculate EBITDA. All you need to do is add depreciation and amortisation, interest, and taxes to your net income. Or, add depreciation and amortisation to your operating income.
EBITDA = Net Income + Interest + Taxes + Depreciation + Amortisation
EBITDA = Operating Income + Depreciation + Amortisation
For example, If a company’s net income is twenty million, depreciation and amortisation are ten million, interest is five million, and taxes are seven million, then that company’s EBITDA is forty-two million. Or, to use the other calculation, if a company’s operating income is twenty million, and depreciation and amortisation is ten million, their EBITDA is thirty million.
Remember to use the EBITDA formula across multiple months so you can see how it fluctuates. Investors might also want to calculate an EBITDA margin. This safety margin accounts for risk, and can help investors make smarter choices.
You need to know how to calculate your EBITDA margin to understand what possible investors are looking for. To calculate EBITDA margin, all you need to do is divide your EBITDA by your total revenue.
Investors might also use EBITDA multiples to make judgements between multiple investments. Some multiples include comparing EBITDA to sales, or research and development costs. If you want to have a good EBITDA multiple, you want to see how it compares to other businesses in your industry.
Do you know how to calculate your EBITDA multiple? To find your EBITDA multiple, simply divide the total value of your company’s operations by your EBITDA.
Like any other metric, the EBITDA isn’t perfect. It doesn’t present a full picture of a company’s finances, which is the point, of course. But that also means there’s room for error and even for manipulation. For example, if your company has a much better EBITDA with one formula versus the other, it would be easy to use those two numbers to present financial improvement that isn’t there.
And, of course, the things that EBITDA leaves out can be very important. Depending on the company and the industry, something like depreciation of equipment might be a bigger concern that really shouldn’t be left out altogether.
When using EBITDA, remember that it’s not part of the recognised Generally Accepted Accounting Principles, or GAAP. There are many business leaders and investors like Warren Buffet who don’t trust EBITDA as a financial metric at all.
As with any other metric, EBITDA is best used as one piece of a larger picture. As long as you are consistent with your use of the two different EBITDA formulas, and as long as you use it as only one part of your financial outlook, it can be a valuable metric.