Accounting principles | business valuation | topics | career center | dictionary | accounting Q & A | quizzes | about us

Browse Accounting Lessons Here

Accounting Terms & Definitions
Accounting for Merchandising Activities
Debits and Credits (Double Entry Accounting)
Business Valuation Formulas
Time Value of Money & Present/Future Values
Complex Debt & Equity Instruments
Common Stock & Shareholder's Equity
Accounting & Finance Ratios
Valuing Common Stock
Corporate Income Taxes
Lower of Cost or Market (LCM) & Inventory Valuation
Chart of Accounts & Bookkeeping
Bonds Payable & Long Term Liabilities
Capital Assets
GAAP, Accrual & Cash Accounting, Information Commodity, Internal Controls & Materiality

What category of browser are you on this website?

EBITDA - Earnings Before Interest, Taxes, Depreciation & Amortization Expense

EBITDA stands for Earnings before Interest, Taxes, Depreciation & Amortization expense. EBITDA is a tool to measure the value of a firm based on its net earnings before non-cash expenses (depreciation & amortization) are recorded, as well as dilutive expenses such as interest expense & taxes. EBIDTA is used by financial valuation experts to measure the true value of a business, especially for private capital firms. Here is why private capital banks like the EBITDA formula:

i) Interest & Taxes - Replace current tax rates & Interest rates with their own tax & interest rates based on the current & new capital structure of the corporation, new debt convenants or refinancing with the banks.

ii) Amortization & Depreciation - These are excluded because they are non-cash expenses for capital or intangible assets which were acquired in prior periods, and do not represent a cash outlay of the organization.

Financial advisors recommend using EBITDA as a way to measure the cash generation activities of an organization. The formula for Earnings before Interest, Taxes, Depreciation & Amortization is:

EBITDA = Net Sales - Operating Expenses = Operating Profit

EBITDA = Operating Profit + Deprecation Expense + Amortization Expense + Taxes

As an example, let's calculate the EBITDA for Checkpoint Software Technology Ltd.

In Millions of USD (except for per share items) 12 months ending 2009-12-31
Revenues $924.42
Other Revenues, Total  
Total Revenue $924.42
Cost of Revenue $133.27
Gross Profit $791.15
Selling/General/Admin. Expenses, Total $277.29
Research & Development $89.74
Depreciation & Amortization  
Interest Expense(Income) - Net Operating  
Unusual Expense (Income) $10.38
Other Operating Expenses, Total  
Total Operating Expenses $510.68
Operating Income $413.74
Income Taxes $88.28

What is EBITDA?

EBITDA = Operating Profit + Deprecation Expense + Amortization Expense + Taxes
EBITDA = $413.74 + $0 + $88.28 + $0
EBITDA = $502.02
EBITDA differs from Operating Income by $502.02 / $413.74 = 21.3%

Drawbacks of using EBITDA

  • EBITDA excludes Interest expense & Income taxes however these are cash expenses and obviously must be paid by the company.
  • EBITDA does not factor in changes in Working Capital which could significantly affect Cash.
  • EBITDA does NOT exclude all non-cash items apart from amortization & interest expense. Examples of such non-cash items include stock options warranted, Inventory markdowns, allowance for doubtful accounts, etc.
  • EBITDA could be misleading due to the fact that a company could understate its Warranty expenses, reserve for bad debt allowances, corporate restructure costs, inventory writedowns and this will lead to a higher EBITDA.

© Accounting Scholar | Privacy Policy & Disclaimer | Contact Us