What Is EBITDA and How Can It Measure Your Company’s Financial Performance?

As an employee, finding out how much money you’re making is easy. In fact, your employer’s HR department does it for you. They subtract your taxes and health insurance payments for you, so just one glance at the check will tell you how much will end up in your bank account.

Owning your own business is a little more complicated.

Not only do you have to calculate and actively pay your taxes, rather than having them deducted from your paycheck, you also have to choose and pay for a health insurance plan, business insurance, any equipment and software you need for your business. Not to mention payroll.

Because of all the different ways your business makes and spends money, calculating the value of your company is never simple.

As accountants, we’ve had to get creative when it comes to figuring out how to calculate the value of your business or estimate cash flow.

We’ve already talked about things like revenue vs profit, but depending on the type of company you have, and the financial goals you have for your business, it might make sense to calculate your Earnings Before Interest, Taxes, Depreciation, and Amortization (EBITDA.)

First, let’s look at why you should calculate your EBITDA in the first place.

Why Your EBITDA Matters

Your EBITDA can give you a clear picture of your company’s performance because it looks at your net income without taking into account some of the ways you might choose to fund your company without cash, such as debt. It also eliminates the taxes your company has to pay on that net income, which can vary. Depreciation and amortization also tend to vary month to month, quarter to quarter, and year to year.

An EBITDA is ideal for getting a good idea of your company’s performance, as well as comparing the financial performance of two different companies.

That means investment bankers will want to calculate your EBITDA if you apply for a business loan. If you’re considering selling your company to another company, they’ll probably calculate your EBITDA as part of their process for determining how large an offer to make on your company.

What Is EBITDA?

Now that we know why you need to know your EBITDA, let’s take a look at what each component of EBITDA is and what it means:

Earnings

The “earnings” referred to in EBITDA is your net income (revenue – expenses) in a given time frame, whether a month, a quarter, or a year. 

Interest

If you have any loans you’re paying back for your business, whether it’s start-up funding in the form of a loan, a mortgage on your office space or any of your equipment, you’ll have to pay interest on those loans.

When calculating your EBITDA, we want to know how much you’re earning before you start paying off that interest.

Taxes

Don’t forget about all the taxes you owe, including federal, state, and local taxes. If your company owns property, you should include property taxes as well. We’ll need to add all those together before including them in the EBITDA formula.

Depreciation and Amortization

Depreciation and amortization both refer to the assets your business owns losing value. The most common example is a car. Most people know that cars plummet in value as soon as they’re driven off the lot. The older they get and the more miles they put on, the lower their value sinks.

If your business owns a vehicle, computer, or any other equipment, chances are good that it’s depreciating in value as you read this.

Amortization refers to intellectual property losing value. If your company owns any copyrights or patents, those usually come with an expiration date. Just like the food in your fridge loses freshness the closer you get to the expiration date, your intellectual property also loses value over time.

But when calculating your EBITDA, we want to know how your company is performing before those assets start losing value.

Calculating EBITDA

Now that we know all the components that go into calculating your EBITDA, let’s look at how that calculation works:

EBITDA = Earnings + Interest + Taxes + Depreciation + Amortization

You start by taking your net income for the time period you’re calculating, then add the amount of interest and taxes you owe for that same time period, then add the amount of value each of your assets (physical and intellectual) lost in that same time period.

For example, let’s say your net income for last quarter was $5,000,000, you owe $1,000,000, in taxes, $1,000,000 in interest, and your assets lost a total of $500,000 in value. You would calculate EBITDA like this:

$5,000,000

+ $1,000,000

+ $1,000,000

+ $500,000

= $7,500,000

It looks easy enough when it’s written out as a simple addition formula with the numbers already filled in for you, but knowing how to find those numbers is another matter entirely. How do you know how much your assets have depreciated in a given time period? How do you calculate how many taxes you paid (or will have to pay)? That’s where a Bookkeeping Doctor can help. Whether you need someone to calculate things like your EBITDA, or just keep track of your income and expenses, I can help. Schedule your FREE consultation to get started.