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Earnings before interest, taxes, depreciation, and amortization, referred to on a shorthand basis as EBITDA is a measure of an organization’s total financial performance and is, sometimes, substituted for net income. It is an avenue used to estimate the cash flow that is available for the payment of debts on long-term assets.

Deeper Definition

Putting it simply, EBITDA is a measure of the profitability of an enterprise that is often deduced from the information presented in the financial statement of a company according to the generally accepted accounting principles (GAAP) that are active in the United States. This is because companies are under no legal requirement to disclose their EBIDTA. However, these earnings can project a wrong representation of the state of things as they typically rule out the cost of capital investments, including plants and equipment. Asides from this, they leave no room for debt-related expenditure as they restore interest expenses and taxes to overall earnings.

Overall, it has proven to provide a more precise assessment of corporate performance by revealing the amount of earnings made before accounting and financial deductions are made. It is used to measure companies against each other and gauge each one’s performance compared to the entire market or industry. Any of the following formulae or methods can be used to calculate the earnings before interest, taxes, depreciation, and amortization.

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

EBITDA= Operating Income+ Depreciation + Amortization

EBITDA Example

If an organization is looking to acquire another organization, the potential acquirer considers his valuation and compares his EBIDTA to the other.

If a company posts revenue of $10 million in a given year with $3 million of product expense, $2 million of operating expenditure, and a further $3 million on amortization and depreciation, the net profit amounts to $2 million. After factoring in the interest expense and taxes, it is found that the EBIDTA is higher than that of the company to be acquired. As such, the takeover can go ahead as planned.

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