Earnings before interest, taxes, depreciation and amortization

A company's earnings before interest, taxes, depreciation, and amortization (commonly abbreviated EBITDA,[1] pronounced /bɪtˈdɑː/,[2] /əˈbɪtdɑː/,[3] or /ˈɛbɪtdɑː/[4]) is a measure of a company's profitability of the operating business only, thus before any effects of indebtedness, state-mandated payments, and costs required to maintain its asset base. It is derived by subtracting from revenues all costs of the operating business (e.g. wages, costs of raw materials, services ...) but not decline in asset value, cost of borrowing, lease expenses, and obligations to governments.

While EBITDA often appears on the non-GAAP financials of a company, such as management presentations, press releases, and equity research reports, EBITDA is not permitted to be recognized on the income statement.[5]

Contrary to profitability metrics like operating income (EBIT) and net income, EBITDA is not considered part of the Generally Accepted Accounting Principles (GAAP) by the SEC,[6] and hence the SEC requires that companies registering securities with it (and when filing its periodic reports) reconcile EBITDA to net income.[7]

Usage and criticism

EBITDA is widely used when assessing the operating performance of a company. EBITDA is useful to assess the underlying profitability of the operating businesses alone. In other words, EBITDA is the operating profit of a company in the given time period, after adjusting for non-cash expenses and non-recurring items (or extraordinary items).

This type of analysis is useful to get a view of the profitability of the operating business alone, as the costs and expenses excluded in the EBITDA computation are largely independent from the operating business.

The EBITDA metric excludes interest and taxes, while adding back non-cash items, such as depreciation and amortization (D&A).

  • Interest: The interest payments depend on the financing structure of the company, which is a discretionary decision by management.
  • Taxes: The tax payments in the relevant jurisdictions as well as the interest payments. In addition, the income tax paid by a company can be influenced by net operating losses (NOLs) and deferred taxes.
  • Depreciation: The depreciation on the fixed asset base, including the depreciation policy chosen, is discretionary to management. For example, the decision between straight-line depreciation and accelerated depreciation can have a profound impact on the annual depreciation expense, despite the total being the same. Depreciation is recognized in accordance to U.S. GAAP (IFRS) accounting policies, where capital expenditures (CapEx) is expensed on the income statement.
  • Amortization: Similar to depreciation, the amortization expense is a non-cash expense, meaning that there was no real movement of cash in the given period. The distinction is depreciation reduces the carrying balance of fixed assets, while amortization reduces the value of certain intangible assets.[8]

Note that not all intangible assets can be amortized, such as goodwill (the excess paid over the fair value of an asset in M&A), among others.[9]

EBITDA is widely used to measure the valuation of private and public companies (e.g. saying that a certain company trades at x times EBITDA, meaning that the company value as expressed through its stock price equates to x times its EBITDA).

EBITDA is often adjusted for extraordinary expenses, i.e. expenses that the company believes do not occur on a regular basis. The most common adjustments include goodwill impairment, inventory write-down (or write-off), bad debt expenses, legal settlements, restructuring costs, transaction fees paid to investment banks, charitable contributions and salaries of the owner or family members.[10][11] The resulting metric is called adjusted EBITDA or EBITDA before exceptionals.

A negative EBITDA indicates a business has fundamental problems with profitability. A positive EBITDA, on the other hand, does not necessarily mean that the business generates positive free cash flow (FCF). This is because the cash generation of a business depends on capital expenditures (i.e. the purchase of fixed assets to drive growth or spending to replace assets that have broken down), taxes, interest and changes in working capital line item.

While a useful metric to analyze profitability, one should not rely on EBITDA alone when assessing the performance of a company. The biggest criticism of using EBITDA as a measure to assess company performance is that it ignores the need for capital expenditures in its assessment. However, capital expenditures are needed to maintain the asset base which in turn allows for generating EBITDA. Warren Buffett famously asked, "Does management think the tooth fairy pays for capital expenditures?".[7] A fix often employed is to assess a business on the metric EBITDA - Capital Expenditures.

Formula

EBITDA can either be calculated starting from operating income (EBIT), or net income.

If starting from operating income, or EBIT, the next step is to add back non-cash expenses, like D&A.[12]

If starting from net income (NI), the adjustments applied include adding back taxes and interest, followed by adjusting for non-cash items.

The depreciation and amortization expense is recorded on the cash flow statement (CFS).

Margin

EBITDA margin refers to EBITDA divided by total revenue (or "total output", "output" differing from "revenue" according to changes in inventory).[13]

The EBITDA margin varies by industry and there is no set benchmark that applies to all sectors. NYU Professor Damodaran publishes a widely referenced data set of the average EBITDA margin per industry.[14]

Variations

Example income statement
Revenue $20,000
Cost of goods sold $8,000
Gross Profit $12,000
Selling, general and administrative expenses $7,000
Earnings before interest, taxes, depreciation and amortisation (EBITDA) $5,000
Depreciation and amortisation $1,500
Earnings before Interest and taxes (EBIT) $3,500
Interest expenses and income $300
Earnings before income taxes (EBT) $3,200
Income taxes $1,000
Earnings after tax (EAT) or Net income $2,200

EBITA

Earnings before interest, taxes, and amortization (EBITA) is derived from EBITDA by subtracting Depreciation.[15]

EBITA is used to include effects of the asset base in the assessment of the profitability of a business.

EBITA can be a more reliable metric than EBITDA in certain circumstances, but has not yet found widespread adoption.

EBITDAR

Earnings before interest, taxes, depreciation, amortization, and rent costs (EBITDAR)
EBITDAR is derived from EBITDA by adding rent costs to EBITDA. It can be of use when comparing two companies in the same industry with different structure of their assets. For example, consider two nursing home companies: one company rents its nursing homes and the other owns its homes. The first business has rent expenses which are included in EBITDA whereas the second company has capital expenditures instead which are not included in EBITDA. Comparing these business on EBITDA level thus is not the right metric and EBITDAR addresses this problem. Other industries where EBITDAR is employed are e.g. hotel businesses or trucking businesses.[16] Related to EBITDAR is "EBITDAL", "rent costs" being replaced by "lease costs".
Earnings before interest, taxes, depreciation, amortization, and restructuring costs (EBITDAR)
Some companies use an EBITDAR where "R" indicates "restructuring costs". While this analysis of profits before restructuring costs is also helpful, such a metric should better be termed "adjusted EBITDA".

EBIDAX

Earnings Before Interest, Depreciation, Amortization and Exploration (EBIDAX) is a non-GAAP metric that can be used to evaluate the financial strength or performance of oil, gas or mineral company.[17]

Costs for exploration are varied by methods and costs. Removal of the exploration portion of the balance sheet allows for a better comparison between the energy companies.

OIBDA

Operating income before depreciation and amortization (OIBDA) refers to an income calculation made by adding depreciation and amortization to operating income.

OIBDA differs from EBITDA because its starting point is operating income, not earnings. It does not, therefore, include non-operating income, which tends not to recur year after year. It includes only income gained from regular operations, ignoring items like FX changes or tax treatments.

Historically, OIBDA was created to exclude the impact of write-downs resulting from one-time charges, and to improve the optics for analysts comparing to previous period EBITDA. An example is the case of Time Warner, who shifted to divisional OIBDA reporting subsequent to write downs and charges resulting from the company's merger into AOL.

EBITDAC

Earnings before interest, taxes, depreciation, amortization, and coronavirus (EBITDAC) is a non-GAAP metric that has been introduced following the global COVID-19 pandemic.

EBITDAC is a special case of adjusted EBITDA.

On 13 May 2020, the Financial Times mentioned that German manufacturing group Schenck Process was the first European company to use the term in their quarterly reporting.[18] The company had added back €5.4m of first-quarter 2020 profits that it said it would have made were it not for the hit caused by 'missing contribution margin and cost absorption reduced by direct financial state support received majorly in China so far'.[19]

Other companies picked up this EBITDAC measure as well, claiming the state-mandated lockdowns and disruptions to the supply chains distort their true profitability, and EBITDAC would show how much these companies believe they would have earned in the absence of the coronavirus.

Like other forms of adjusted EBITDA, this can be a useful tool to analyse companies but should not be used as the only tool.

See also

References

  1. ^ "EBITDA - Financial Glossary". Reuters. October 15, 2009. Archived from the original on June 30, 2012. Retrieved February 9, 2012.
  2. ^ Professional English in Use Finance, Cambridge University Press
  3. ^ "Pronunciation of ebitda - how to pronounce ebitda correctly". Howjsay.com. October 29, 2006. Retrieved January 21, 2012.
  4. ^ "EBITDA - alphaDictionary – Free English On-line Dictionary". Alphadictionary.com. May 3, 2001. Retrieved January 22, 2012.
  5. ^ "SEC.gov | Non-GAAP Financial Measures". www.sec.gov. Retrieved 2024-03-06.
  6. ^ "Frequently Asked Questions Regarding the Use of Non-GAAP Financial Measures". www.sec.gov. Division of corporation finance, SEC, USA. Retrieved January 24, 2018.
  7. ^ a b "Top Five Reasons Why EBITDA Is A Great Big Lie". Forbes. December 28, 2011. Retrieved November 15, 2012.
  8. ^ Bragg, Steven (2023-12-08). "The difference between amortization and depreciation". AccountingTools. Retrieved 2024-03-06.
  9. ^ "26 CFR § 1.197-2 - Amortization of goodwill and certain other intangibles". LII / Legal Information Institute. Retrieved 2024-03-06.
  10. ^ "UNDERSTANDING EBITDA AND NORMALIZING ADJUSTMENTS".
  11. ^ "Adjusted EBITDA Definition - Free Tool - ExitPromise". April 4, 2014.
  12. ^ "EBITDA Primer". Wall Street Prep. Retrieved 2024-03-06.
  13. ^ "What is EBITDA?". BusinessNewsDaily. May 9, 2013. Retrieved November 15, 2014.
  14. ^ "Operating and Net Margins". web.archive.org. 2024-02-28. Retrieved 2024-03-06.
  15. ^ "EBITA". Retrieved November 30, 2014.
  16. ^ Cederholm, Teresa (October 2014). "Why the EV/EBITDAR multiple is best for valuing hotel companies".
  17. ^ "Earnings Before Interest, Depreciation, Amortization and Exploration (EBIDAX)". Investopedia. June 28, 2010. Retrieved February 12, 2018.
  18. ^ "Pandemic spawns new reporting term 'ebitdac' to flatter books". The Financial Times. May 13, 2020. Archived from the original on 2022-12-10. Retrieved June 10, 2020.
  19. ^ "Investor Relations: Financial Reports 2020". Schenk Group GmbH. May 12, 2020. Retrieved June 10, 2020.

Further reading

  • McLaney, Eddie; Atrill, Peter (2012). Accounting: An Introduction (6th ed.). Harlow, Eng.; New York: Pearson. ISBN 9780273771838. OCLC 989363259.

External links

  • Investopedia definition of EBITDA
Retrieved from "https://en.wikipedia.org/w/index.php?title=Earnings_before_interest,_taxes,_depreciation_and_amortization&oldid=1212098058"