EBITDA

How is it calculated?

The acronym EBITDA stands for Earnings Before Interest, Taxes, Depreciation and Amortization.  Basically it is calculated by taking a businesses net income and adding back any taxes, depreciation, amortization and interest expense to determine the profit generated to pay debt payments.  

Typically, EBITDA is calculated in conjunction with other ratios such as the Debt Service Coverage Ratio (DSCR) where the EBITDA determined is divided by the debt payment requirements during the corresponding timeframe of the EBITDA calculated.

The reasons why the following items are added back is as follows:

Interest Expense - Interest expense is added back because typically EBITDA is used in conjunction with a DSCR.  In the DSCR, the EBITDA amount is divided by the Principal and Interest (P&I) requirements of the businesses loans.  If interest expense was not added back, it would be like the business was paying the interest portion of their payment twice, and as a result, the businesses repayment ability would be understated. 

Taxes - Taxes are added back due to the timing of when loan payments versus tax payments are made.  Typically loan payments are made on a more frequent basis than tax payments, and due to this the money expensed for taxes is still available (still in the checking account) when loan payments are being made.  

The tax portion of the EBITDA calculation would be one area that varies by bank on how they decided to calculate this figure.  Many banks choose to not add back taxes because from their viewpoint, if there isn’t enough money to go around for all, then there is ultimately going to be a problem.  

Depreciation & Amortization - Depreciation and Amortization are added back for the same reason.  That reason is because ultimately Depreciation and Amortization are an allocation of a previously purchased long term asset (or intangible asset) being applied during the future years where the business benefited from the presence of that long term asset.  This is a calculation completed to determine a business’s tax obligation, but the reason why it is added back in this calculation is because even though that expense has occurred, it is a non-cash expense (meaning the money never actually left the businesses checking account) and as a result that money is still available to pay its loans.

Other things to pay attention to when determining an accurate EBITDA is the only include income or expenses that meet the following requirements:

1. Stable
2. Recurring
3. Likely to continue

If an income or expense item cannot meet these requirements, it should be considered for exclusion in the EBITDA calculation.  

Goal of the Ratio

The goal of this calculation is to determine the profit available to service their debt.

When is it used?

EBITDA is used in all situations

Rules of Thumb

Higher is better.

What changes in the ratio could mean:

Some example reasons why EBITDA can change:

Changes in income statement performance:

1. Revenue
2. Gross Profit Margin
3. Overhead expenses

Other Relevant Terms

• Income Statement
• Debt Service Coverage Ratio
• Capacity
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