EBITDA Primer

How to Calculate EBITDA

EBITDA reflects the operating performance attributable to a company’s core business activities, expressed on a normalized basis.

The widespread use of EBITDA is attributable to the fact that the profit metric is independent of discretionary capital structure decisions and is unaffected by the tax rate, which is jurisdiction-dependent.

EBITDA measures the normalized operating performance of a particular company, and its capacity to generate consistent, recurring cash flow from its core business activities.

EBITDA is a non-GAAP financial measure that deliberately excludes interest and income taxes, as well as adjusts for non-cash items, such as depreciation and amortization (D&A).

Therefore, U.S. GAAP accounting standards prohibit the recognition of EBITDA on the income statement.

The step-by-step process to calculate EBITDA is as follows:

• Step 1 ➝ Calculate Operating Income (EBIT)
• Step 2 ➝ Add Back Non-Cash Expenses (D&A)
• Step 3 ➝ Adjust for Non-Recurring Items (Extraordinary, One-Time Items)

EBITDA Formula

The top-down EBITDA bridge starts with operating profit (EBIT) from the income statement and adds back D&A from the cash flow statement (CFS).

The formula for calculating EBITDA starts with operating income (EBIT) and adjusts for non-cash items, such as depreciation and amortization (D&A).

On the income statement, the non-cash D&A expense is seldom broken out as a separate line item, apart from COGS and operating expenses (SG&A).

Therefore, one practical tip is to retrieve the D&A expense from the cash flow statement (CFS) to ensure accuracy.

On the other hand, the bottom-up EBITDA bridge starts with net income and adds back non-operating items (e.g. income taxes and interest) to arrive at EBIT, from which non-cash items like D&A are added back to arrive at EBITDA.

EBITDA = Net Income + Taxes + Interest Expense + Depreciation + Amortization

The formula to calculate EBITDA starts with net income—from which taxes, interest expense, depreciation, and amortization are added back.

EBIT vs. EBITDA: What is the Difference?

EBITDA and EBIT are each pre-tax, capital-structure-neutral profit metrics with more commonalities than differences.

• EBITDA ➝ “Earnings Before Interest, Taxes, Depreciation, and Amortization”
• EBIT ➝ “Earnings Before Interest and Taxes”

The operating costs incurred by a company—excluding non-cash items like D&A—are subtracted from revenue to calculate EBITDA.

On the other hand, the operating expenses incurred, including non-cash items (D&A), are subtracted from gross profit to calculate EBIT.

EBIT is an accrual-accounting-based GAAP profit metric, whereas EBITDA is a non-GAAP, hybrid measure of profitability.

The exclusion of depreciation and amortization in the EBITDA formula—and inclusion in EBIT—is the differentiating factor between the two metrics.

The percent differential between EBITDA and EBIT—i.e., the “spread”— is contingent on industry-specific factors, like capital intensity.

For instance, the variance between the two metrics can be substantial for capital-intensive companies with significant Capex spending requirements.

What are the Full-Form EBITDA Components?

The full-form components of EBITDA are each described in the following table.

Why is EBITDA a Non-GAAP Measure?

EBITDA is a non-GAAP measure, thereby, there is no standardized, consistent set of rules dictating the specific items that belong in the formula.

Non-GAAP measures are not permitted to be reported on a company’s financial statements filed with the Securities and Exchange Committee (SEC).

However, sell-side equity research analysts, buy-side analysts, and other participants in the public equities market pay considerable attention to non-GAAP measures.

In fact, certain public companies prioritize their EBITDA in management presentations, press releases, and earnings calls based on the notion that non-GAAP metrics reflect their operating performance more accurately than accrual-based metrics.

EBITDA vs. Net Income: What is the Difference?

EBITDA and net income are each common measures of profitability, but the former is oriented around a company’s core operating performance, whereas the latter represents the accounting profitability per GAAP reporting standards.

From net income, EBITDA can be calculated by adding back interest, taxes, depreciation, and amortization.

The adjustments applied to net income—e.g. interest, taxes, depreciation, and amortization—are each non-operating items (and EBITDA only measures operating performance).

The net income (or the “bottom line”) is the accounting profitability of a company, inclusive of operating and non-operating expenses and non-operating income.

Unlike EBITDA, net income is recognized on the income statement since the metric abides by the reporting guidelines established under GAAP.

The drawback to net income, however, is that accrual accounting is imperfect, and the metric is impacted by one-time and non-recurring items, distorting the implied profitability. Hence, a company that reports positive net income can still be at risk of becoming distressed and filing for bankruptcy.

EBITDA is, therefore, far better suited for comparison between companies operating in the same (or adjacent) industries with different capital structures, tax rates, and depreciation policies.

Why is D&A an Add-Back to EBITDA?

The cash flow statement (CFS) reconciles net income—the GAAP-based accounting profit of a company—for non-cash items and the change in net working capital (NWC) to track the real movement of cash in a given period.

The recognition of the D&A expense on the income statement is to abide by the accrual accounting reporting guidelines (U.S. GAAP) established by the Financial Accounting Standards Board (FASB).

• Depreciation ➝ The depreciation expense is embedded within the cost of goods sold (COGS) or operating expenses (SG&A) section on the income statement. The recognition of depreciation reduces the carrying value of a company’s fixed assets (PP&E) over its useful life.
• Amortization ➝ The amortization expense is virtually identical to the concept of depreciation. The distinction is that amortization is the incremental reduction in the carrying value of intangible assets.

The depreciation expense is the allocation of the initial cash outlay associated with capital expenditures (Capex)—i.e., the purchase of a fixed asset (PP&E)—over its useful life to “smoothen” the recognition of the expenditure on the income statement and abide by the matching principle in accrual accounting.

The term “normalized operating expenses” refers to a company’s recurring operating costs, like SG&A and R&D, while excluding non-cash expenses.

Hence, the depreciation and amortization expense (D&A) is treated as a non-cash add-back on the cash flow statement (CFS) since no actual outflow of cash occurred. Likewise, the equation to solve for EBITDA adds back the non-cash D&A expense to operating income (EBIT) based on the same logic.

What is a Good EBITDA?

The EBITDA profit metric, by itself as a standalone metric, does not offer much practical insight into a company’s recent operating performance.

For the sake of comparability, EBITDA must be divided by revenue in the corresponding period to calculate the EBITDA margin, a standardized measure of profitability widely used across a broad range of industries.

The formula to calculate the EBITDA margin is equal to EBITDA divided by revenue, expressed as a percentage.

The EBITDA margin answers the following question, “For each dollar of revenue generated, what percentage of it trickles down to EBITDA?”

The EBITDA margin is expressed as a percentage and measures a company’s operational efficiency in producing sustainable operating profits.

Generally speaking, an EBITDA margin above 10% is viewed as “good,” while an EBITDA margin that exceeds 20% is perceived as “great.”

• Historical Benchmark ➝ Once converted into percentage form, a company’s EBITDA margin can be compared to historical periods to analyze the recent trajectory of its margin profile.
• Comparative Analysis ➝ The company’s EBITDA margin can also be used to grasp its relative standing with regard to the industry benchmark, which is set by its comparable industry peers.

There is no “good” EBITDA value per se without adequate context, such as the specific industry in which the company operates, the market size of the industry (i.e., potential revenue opportunity), and the company’s current placement in its overall life cycle, at the very least.

Learn More → Profit Margins by Sector (Source: Aswath Damodaran, NYU Stern)

How to Forecast EBITDA

EBITDA is seldom forecasted in practice because of the implicit assumption that the underlying components of the metric are tied to revenue at a fixed percentage.

However, one exception is to perform a “back-of-the-envelope” analysis on a late-stage, mature company exhibiting stable operating performance and minimal growth (e.g., 3% to 5% YoY growth).

For instance, a private equity firm might forecast the EBITDA of a company to build a short-form LBO model to vet a potential acquisition.

The formula to forecast EBITDA is equal to the product of the EBITDA margin assumption and the projected revenue in the coinciding period.

The EBITDA margin assumption is normally set based on the historical margin profile of the company and recent trajectory in the trailing couple of periods, including the industry benchmark (“comps”).

But to reiterate—as it bears repeating—forecasting EBITDA is merely a “quick-and-dirty” method to determine the economic feasibility of an investment opportunity and precedes a more granular analysis, assuming the acquisition is deemed worthwhile.

What are the Pros and Cons of EBITDA?

EBITDA is frequently used across all fields of corporate finance because of the ease of computing the metric (i.e.,” back of the envelope”), despite the negative criticism supporting the notion that EBITDA is a flawed measure of profitability.

• Widespread Use ➝ The prevalence of EBITDA is particularly common in corporate valuation and mergers and acquisitions (M&A), such as the offer price (or the purchase multiple).
• Capital Structure Neutral ➝ Since EBITDA removes the impact of one-time, extraordinary items and is considered a capital-structure neutral metric, comparisons among different companies are easier (i.e., closer to being “apples-to-apples.”).
• Unaffected by Taxes ➝ The prevalence of EBITDA in valuation multiples is tied to the unlevered aspect of the metric, wherein the effects of financing and taxes are excluded. The tax rate, which determines the income tax owed, can vary based on jurisdiction.
• Non-Cash Items ➝ The EBITDA metric is adjusted to remove the effects of non-cash expenses, such as depreciation and amortization (D&A). In effect, the operating metric is not distorted by non-cash items that can be substantial for certain companies, particularly those operating in capital-intensive sectors (e.g., manufacturing, industrials, and telecom).
• Non-Recurring Items ➝ Often, non-recurring items or one-time events, such as inventory impairment and PP&E impairment, lead to write-downs or write-offs for bookkeeping purposes, which affects a company’s GAAP-based financials. Considering such extraordinary events are non-recurring, removing the effects is rational for forecasting and peer comparisons (i.e., “scrubbed”).

However, despite its widespread use, EBITDA receives criticism for portraying an inaccurate and potentially misleading representation of a company’s cash flow profile (and profitability).

The common sources of criticism supporting the notion that EBITDA is a flawed measure of cash flow are as follows:

• Capital Expenditure (Capex) ➝ The primary source of criticism surrounding EBITDA is the neglect of Capex. For most companies, Capex is a major recurring cash outflow captured on the cash flow statement, but the full expenditure is not recognized on the income statement. Instead, Capex is allocated across the fixed asset’s useful life assumption via depreciation because the monetary benefits are anticipated to exceed one year (>12 months).
• Change in Net Working Capital (NWC) ➝ The change in NWC is the increase (or decrease) in a company’s operational current assets and operational current liabilities. The change in NWC can significantly impact free cash flow (FCF), but EBITDA neglects the cash needed to fund working capital needs.
• Non-GAAP Measure ➝ Since EBITDA is a non-GAAP metric, the lack of standardization and inconsistency by which specific items are included (or excluded) offers the management team more discretion on the adjustments to apply (“wiggle room” for earnings manipulation).

How to Calculate FCFF from EBITDA

The free cash flow to firm (FCFF) metric—or “unlevered free cash flow”—is the residual cash flow attributable to all capital providers, including common equity shareholders, preferred stockholders, and debt lenders.

The formula to calculate the free cash flow to firm (FCFF) starts with NOPAT and adjusts for D&A, the change in NWC, and Capex.

Therefore, to calculate free cash flow to firm (FCFF) starting from EBITDA, the first step is to deduct D&A from EBITDA to arrive at operating income (EBIT).

The next step is to tax-affect EBIT to calculate net operating profit after taxes (NOPAT), or “EBIAT”.

Once NOPAT has been calculated, the subsequent steps are to adjust for non-cash expenses (D&A), subtract the change in net working capital (NWC), and deduct Capex, resulting in FCFF.

The “[(EBITDA – D&A) × Tax Rate]” component of the equation computes NOPAT. Therefore, the adjustments applied are identical thereafter to arrive at FCFF from EBITDA.

EBITDA Calculator — Excel Template

We’ll now move on to a modeling exercise, which you can access by filling out the form below.

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1. Income Statement Assumptions

Suppose we’re tasked with calculating the EBITDA for a company that generated $100 million in revenue as of its latest fiscal year.

The operating costs incurred by the company were $25 million in COGS, $20 million in SG&A, and $10 million in R&D.

• Revenue = $100 million
• Cost of Goods Sold (COGS) = ($25 million)
• Selling, General and Administrative (SG&A) = ($20 million)
• Research and Development (R&D) = ($10 million)

By subtracting COGS from revenue, we can calculate our company’s gross profit, which comes out to $75 million (and gross margin of 75%).

• Gross Profit = $100 million – $25 million = $75 million

The next profit metric to calculate is operating income (EBIT), which equals gross profit minus operating expenses, i.e., the SG&A and R&D expenses.

Upon inserting the provided historical data into the formula, the operating income (EBIT) of our company comes out to $45 million (and operating margin of 45%).

• Operating Income (EBIT) = $75 million – $20 million – $10 million = $45 million

2. GAAP to Non-GAAP Reconciliation

The next section from the operating income line is the non-operating items section, where the only line item recorded is $5 million in interest expense.

If interest expense is deducted from EBIT, we are left with earnings before taxes (EBT), otherwise known as pre-tax income.

• Interest Expense, net = ($5 million)
• Pre-Tax Income (EBT) = $45 million – $5 million = $40 million

Only one step is left before we reach our company’s net income, which is calculated by subtracting taxes from pre-tax income (EBT).

The tax rate is assumed to be 20%, which we’ll multiply by our pre-tax income (EBT), which comes out to $8 million in taxes.

After subtracting the $8 million tax expense from our EBT, we can determine our company’s net income to be $32 million, which reflects the accrual-accounting based profitability inclusive of all operating and non-operating costs.

• Taxes = ($8 million)
• Net Income = $40 million – $8 million = $32 million

However, before calculating EBITDA starting from either revenue (“top-down bridge”) or net income (“bottom-up bridge”), we are still missing one critical assumption: the depreciation and amortization (D&A) expense.

The D&A expense is embedded within COGS and operating expenses on the income statement (and rarely broken out separately).

For illustrative purposes, we’ll assume the company recognized $5 million in depreciation and amortization (D&A) on the cash flow statement (CFS).

• Depreciation and Amortization (D&A) = $5 million

3. EBITDA Calculation Example (Top-Down Bridge)

Our next section comprises two parts, where we’ll calculate the EBITDA of our hypothetical company using the top-down bridge followed by the bottom-up bridge.

Under the top-down method, we’ll start by linking to EBIT from our income statement and adding back the $5 million in D&A, which equals $50 million in EBITDA.

• EBITDA = $45 million + $5 million = $50 million

By dividing our company’s EBITDA by revenue, the EBITDA margin is 50%.

• EBITDA Margin (%) = $50 million ÷ $100 million = 50.0%

4. EBITDA Calculation Example (Bottom-Up Bridge)

In contrast, the bottom-up method to calculate EBITDA starts with net income (or “accounting profits”) from the income statement.

The net income (the “bottom line”) is inclusive of all operating and non-operating costs, such as COGS, SG&A, and R&D.

To calculate EBITDA from net income, we’ll add back taxes, interest expense, and D&A to arrive at an implied EBITDA of $50 million (and an EBITDA margin of 50%), confirming our prior calculation is, in fact, correct.

• EBITDA = $32 million + $8 million + $5 million + $5 million = $50 million
• EBITDA Margin (%) = $50 million ÷ $100 million = 50.0%