The term EBITDA, familiar to many, is a widely used financial metric to assess a company’s operational profitability. EBITDA stands for “Earnings Before Interest, Taxes, Depreciation, and Amortization” and is often employed because it provides a clearer view of a business’s core operational profitability by eliminating the effects of financial, tax, and investment decisions.
To better understand how EBITDA works, let’s consider the case of a small company that offers commercial cleaning services as an example. But first, it’s important to evaluate the company’s financial situation:
The company has the following financial results for one year:
- Annual Revenue: USD 200,000
- Operating Expenses (including salaries, supplies, and other operational costs): USD 120,000
- Interest on debt: USD 10,000
- Taxes: USD 12,000
- Depreciation of cleaning equipment: USD 3,000
- Amortization of a bank loan used to purchase vehicles: USD 2,000
The goal is to calculate the company’s EBITDA to better understand its operational performance without considering the effects of financing decisions and accounting policies.
EBITDA Calculation
First, we need to determine the net operating income before deducting financial expenses, taxes, depreciation, and amortization.
Operating Income before deducting interest, taxes, depreciation, and amortization: Operating Income = Annual Revenue – Operating Expenses = USD 200,000 – USD 120,000 = USD 80,000
Now, to calculate EBITDA, we add back depreciation and amortization, as these are non-cash items, meaning they do not represent actual cash outflows, as well as interest and taxes, which are not included in EBITDA:
EBITDA = Operating Income + Depreciation + Amortization = USD 80,000 + USD 3,000 + USD 2,000 = USD 85,000
The company’s EBITDA is USD 85,000. This value indicates that, excluding costs related to financing (interest), tax decisions (taxes), and accounting policies (depreciation and amortization), the company generated USD 85,000 from its core operations during the year.
This metric is useful for comparing this company’s operational performance with other companies in the cleaning industry, regardless of how they finance their assets or manage their tax obligations. For example, if the company is considering expansion or seeking new investors, EBITDA would give these potential investors a clear view of how profitable the company is based solely on its daily operations.
In summary, EBITDA is a valuable tool for understanding a company’s operational health, especially in cases where variations in financial expenses and accounting decisions could distort the perception of its profitability. In this example, EBITDA provides a clear and concise picture of how the company is managing its daily operations, making strategic decision-making easier for both management and potential investors.