What is EBITDA in business accounting?

Julie Palmer

Regional Managing Partner

2 Minutes to read

Home
Insights
Articles
What is EBITDA in business accounting?

Updated: 9th May 2020

When Would EBITDA Be Used?

EBITDA is a commonly used acronym in business accounting, and means Earnings Before Interest, Tax, Depreciation, and Amortisation. It helps accountants and other finance experts evaluate business profitability and performance as well as providing information to investors and being an aid for business valuation in a sale.

The metric does have its critics who claim that it can be misleading, but EBITDA is widely used in the finance world and can offer a deeper insight into a company’s operational performance than would otherwise be possible.

How does EBITDA work?

Essentially, EBITDA is a measurement of a business’ net income, with the elements making up the metric being found in the profit and loss account and balance sheet. In this respect it’s a relatively straightforward calculation to carry out.

Knowing how to read the results and understand their implications, however, is paramount. Business expenses not necessarily related to core profitability – in other words, interest, tax, depreciation, and amortisation – are excluded, presenting a potentially clearer long-term view of profitability.

When the results are used in comparison with other businesses of a similar nature, or against competitors within the same industry, the results can provide a valuable insight into how the business is performing on an operational level. In simple terms, a higher EBITDA margin when compared with a competitor is a positive outcome.

The reasoning behind EBITDA

The idea behind EBITDA is to remove the non-operating expenses and specific non-cash expenses that are particular to each organisation:

Interest is an expense incurred following a financing decision
The rate of tax paid is decided by the government
Depreciation and amortisation both derive from accounting decisions within a company

In other words, decisions made externally or because a particular path is being followed that’s unique to a business, aren’t allowed to influence the result.

"Essentially, EBITDA is a measurement of a business’ net income, with the elements making up the metric being found in the profit and loss account and balance sheet. In this respect it’s a relatively straightforward calculation to carry out."

Why is EBITDA disliked by some?

Critics of EBITDA are typically concerned that the results could be skewed, whether deliberately or otherwise. Taking depreciation as an example, in an asset-rich business the true cost of running that business may not be reflected in the result as it wouldn’t include the considerable depreciation expense.

The metric may also paint a misleading picture of highly leveraged businesses whose interest payments are high, but have been excluded. Furthermore, EBITDA isn’t regulated by UK GAAP – Generally Accepted Accounting Principles – the framework of accounting standards adopted in the UK, published by the Financial Reporting Council (FRC).

When assessing a business’ performance taking a perspective that’s as wide as possible is advisable, using EBITDA in conjunction with other financial analytical methods rather than as a standalone metric.

If you would like more information about using EBITDA in your business, our experts at Real Business Rescue can help. Our team has industry wide experience and will provide guidance you can rely on. We work from a broad network of offices around the UK, and can offer you a same-day consultation free-of-charge.