Understanding EBITDA

Many organizations use EBITDA as a metric to measure performance, yet many non-finance managers are completely baffled by the metric. It's not fun being measured by a metric you don't understand.

What does EBITDA stand for?

EBITDA is an acronym for

E - Earnings

B - Before

I - Interest

T - Tax

D - Depreciation

A - Amortization

Earnings is a another word for Net Profit After Tax.

This is normally the final number on the income statement (P&L)

Take a look at this clip to see how we calculate EBITDA using a simple income statement:

Why it it useful to know our earnings before deducting Interest, tax, depreciation and amortization?

Let's analyze each one and see why we might want to add it back:

Interest - How much interest the company incurs is normally determined by executives who decide what the capital structure of the company should be (how much we fund by debt and how much by equity) It has little bearing on current operations and how well the company is currently doing and so we add this back in the EBITDA calculation.

Tax - This is determined by the authorities and can vary by location or country. In order to compare apples with apples - we add back tax as the tax expense is out of the company's control.

Depreciation - we depreciate fixed assets at a set percentage per year. This means - our assets reduce and our depreciation expense (in the income statement) increases each year. However, this expense is based on historical capital expenditure that the company made and doesn't say anything about current operations and how well the business is currently doing - and so we add back depreciation too!

Amortization - this is very similar to depreciation - we depreciate fixed assets and we amortize intangible assets (like patents, trademarks, copyrights, goodwill etc..) The expense is incurred as a result of amortizing an intangible asset. Again, this is based on historical decisions and doesn't influence the organization's current operations and current profitability - and so we also add back amortization.

How can you influence EBITDA?

A non-finance manager has the ability to improve EBITDA by increasing sales prices, by purchasing cheaper inventory from suppliers and by managing costs (salaries, rent, advertising etc..)

EBITDA essentially strips away all the things staff don't have control over and focuses on the items they do have control over.

If you'd like to learn more about EBITDA, CLICK HERE to watch the full LinkedIn Live I did yesterday entitled - understanding EBITDA.

Have a great weekend.

Best,

Mark

PS - If your non-finance managers are baffled by EBITDA and other key financial metrics and you need to upskill them to be more financially savvy, please reach out to schedule a call or fill in a contact form on our website - www.accountingmadeeasy.co