What is EBITDA?
EBITDA is the abbreviation for “Earnings Before Interest, Taxes, Depreciation and Amortization.” It is a measure of overall profitability of a business.
How are EBITDA and EBITA margin calculated?
EBITA = earnings before interest, taxes, depreciation, and amortization.
EBITDA margin = EBITDA divided by total revenue.
EBITDA and EBITDA margin help determine the operating efficiency and direct cash flow of the company. It is represented as a dollar amount or a percentage of total revenue. Assuming that EBITDA is $10 million and the total revenue for a period of time is $44 million, the EBITDA margin is: 10/44 = 22.7% for the period.
Who Uses EBITDA?
EBITDA gives an overall view of businesses’ cash flow and profitability, and measures operational efficiency to a certain extent.
- CEOs and the leadership team of a company need EBITDA to get a picture about how well or poorly the company is doing, and where it’s positioned among peers/competitors.
- Analysts, M & A (mergers and acquisitions) and other professionals such as investment bankers, attorneys, valuation experts, CPAs as well as buyers, sellers and brokers, often use EBITDA margin as an easy metric comparing various sizes of companies and different industries.
- Investors may use EBITDA margin as a better indicator than other profit margins because EBITDA margin measures a business’ annual cash flows while downplaying tax and financing activity.
Why is EBITDA useful?
An EBITDA margin allow an organization’s leadership, investors or analysts to make informed decisions about efficiency of operating profit and cash.
- Helps a company evaluate how efficiently their resources and operating cash are used, by seeing the correlation between operating cash flow and revenue;
- Measures the growth of a business over years by comparing annual EBITDA margins;
- Compare efficiency with others in the same industry – better margin, more efficiency;
- Allow investors or analysts to see how a company uses its operating cash in relationship to the revenue.
Why can EBITDA be misleading?
- By excluding debts, EBITDA margin can be misused to make a company with lots of debt and/or higher interest payment look more profitable than it actually is;
- Low profit companies can overestimate their position due to the higher EBITDA margin than a profit margin measured by GAAP metric.
Use both GAAP metrics and EBITDA to determine an organization’s financial health
Under the guidelines of GAAP (generally accepted accounting principles) requirements for corporate accounting, a profit margin is calculated using one of the three principles: gross profit margin, operating profit margin or net profit margin. These are indicators of a business’ financial health because GAAP standardizes profit margins. Net profit margin is often used as a good indicator for evaluating profitability based on expenses and revenues.
a2zCFO, both the Right and Left Arms for your organization:
As a consulting CFO, I set up profits and loss statements to easily derive EBITDA and net income, and help business owners and management “keep your ship on course.”
We help with any aspect of financial management from A to Z. By providing trusted financial advice, I create financial and goal clarity, resulting in increases in cash, profitability and sales all the while preparing the business strategically for a successful exit when the time is right.
- Works at client’s location and directly with client’s staff;
- Affordable and flexibility in hours – 4 hours a month to short term full time assignment;
- Excels at messy and difficult clean up situations;
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- Cradle to grave services – from bootstrapped startups to exit transition service experience.
Please call me (925) 216-5058 or email: rolf@a2zCFO.com
A2Z CFO, we keep your ship on course.