EBITDA helps strip away certain financial elements to give you a clear view of your company's operational health. And, for businesses where every strategic decision counts, comprehending EBITDA isn’t just about seeing numbers; it's about understanding the story behind those numbers.
Calculating your business’s EBITDA isn’t the easiest of tasks, especially when there’s so much that goes into it. But, at takepayments, we’ve taken the guesswork out of EBITDA with our handy calculator — so let’s jump in.
EBITDA is an earnings metric that uses a neutral structure, meaning that it won’t account for the different ways a business might use cash, debt, equity or other capital within its financial operations. It stands for ‘Earnings before interest, taxes, depreciation and amortisation’ and is an alternative measurement of profitability used by banks and businesses instead of net income.
For example, if you approach a bank for a business loan, there’s a high chance they’ll use EBITDA to determine whether your business can repay its debts.
Before we explain how to calculate EBITDA, you’ll need a run-down of what each part of the formula means:
Earnings
Earnings are the net profit as you’d report to HMRC — this would also include any funds you’ve generated from sales minus the costs you’d deduct as legitimate business costs.
Before
This indicates that the earnings are calculated before removing the costs that are listed below.
Interest
These are the expenses associated with borrowing money. It can be from various sources like bank loans, bonds, convertible debt, or lines of credit.
Debt burdens, for example, indicate how heavily a company relies on debt financing. A higher interest expense can mean more debt, which could pose risks if the company's income isn’t stable.
Taxes
This refers to the income taxes that a company is obligated to pay to the government. These taxes are based on the company’s taxable income, which is different from its accounting income.
Taxes will also vary from region to region. Since they’re a function of jurisdictions' tax rules, most people prefer to add them back.
There are two different ways to calculate EBITDA: one based on net income and the other on operating income, both of which will usually arrive at the same end result.
Since EBITDA is a measure of a company's profitability, generally, the higher the better.
Investors may think that a ‘good’ EBITDA is one that provides them with a lot of detail surrounding the ins and outs for an additional perspective on a company's performance.
EBITDA is not equivalent to a business’s profit, since profit is the amount of money a company earns after all expenses have been deducted and EBITDA specifically excludes taxes, interest, depreciation, and amortisation.
Yes, EBITDA does include salaries. Salaries and wages are operating expenses and are part of the ordinary, day-to-day costs incurred in running a business, so it’s important that these are included.
A debt-to-EBITDA ratio measures how likely a company is to pay off its debts. If a business has a high ratio, it could mean that its debt is too heavy of a financial burden for investors or banks to consider investing in.
The end of the tax year is a great time to work out your business's EBITDA and understand its financial health for the start of the new tax year — and there are a whole range of other reasons why the EBITDA metric is used:
1. Comparability across companies
One of the primary reasons to use EBITDA is to compare the financial performance of different companies. By removing expenses like interest and tax, EBITDA provides a cleaner view of a company's operational profitability without the effects of financing and accounting decisions. This is particularly useful in comparing companies with different capital structures or tax environments.
To compare competitor businesses’ EBITDA with your own, some public companies may publish their EBITDA as part of their quarterly or annual reports. Or, you can work it out using our EBITDA calculator and their financial statements if they’re made public.
2. Focus on operating performance
EBITDA concentrates on the earnings from core business operations. It helps stakeholders understand how well a company is managing its operational costs and generating income from its primary business activities, independent of external factors.
3. Indicator of cash flow
EBITDA can be a useful proxy for understanding a company’s potential to generate cash flow from its operations. Since it adds back non-cash expenses (depreciation and amortisation) and excludes interest and taxes, it can provide a clearer picture of the cash a company generates through its operations, which is vital for assessing its financial health.
This measure of determining a company’s financial health is crucial for securing business loans. If your business is looking to take out a loan, banks and financial institutions will probably use EBITDA to understand how likely it is that your business can repay the debt. A low or below-average EBITDA margin may indicate to a bank that your company could struggle to repay and be a financial risk.
It’s clear that EBITDA is more than just a number on a balance sheet; it’s a powerful tool for understanding and steering your business in the right direction.
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