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EBITDA: understand what it is and how to calculate it

EBITDA: understand what it is and how to calculate it

When the moment comes to release company results, many figures, mainly those of a financial nature, are difficult to interpret for those who have less technical knowledge.

Even more experienced professionals can have difficulty in analyzing financial information and in defining the future direction of a company. In these cases the EBITDA indicator is often used because it presents financial information in a more managerial manner.

Do you know what EBITDA is used for? Let’s take a look!

The concept of EBITDA

EBITDA is defined as earnings before interest, taxes, depreciation and amortization. It’s used to identify how much revenue a company manages to produce through its main operations, while ignoring the effects of taxes, interest and charges. It also ignores depreciation and amortization, because even though they affect the result, they do not represent financial outlays.

EBITDA is important, because it serves as a complement to information about a business’s profitability and rate of return. This information represents legal obligations which frequently do not involve the managerial and strategic aspects necessary for correct decision making.

Calculating EBITDA

EBITDA is calculated based on operating profit, which is nothing more than net revenues which have already been reduced by taxes, operating costs and expenses, and financial expenses, those that are incurred with interest and financial charges.

After obtaining this figure, the values related to depreciation and amortization should be added. These values are part of operational costs and expenses and represent just economic and not financial costs.

Interest and financial charges should be removed, because they represent company efforts that are not directly linked to generating revenue. In this case, they should be added to the operating profit before taxes.

Even though it’s of a voluntary and non-mandatory nature, openly traded companies often release EBITDA figures to make their financial information more transparent to society and to facilitate the work of analysts.

The uses of EBITDA

Even though it has its limitations, like any index, EBITDA can calculate a business’s productivity and efficiency, since it separates non-financial items from financial items. Analyzed historically, it can help one determine how a business has evolved in terms of generating operating cashflow and productivity.

One limitation of using EBITDA is related to reinvestment, which is a factor associated with the generation of depreciation in a business. The need for reinvestment varies from business to business, but it is a fact that EBITDA does not consider the effects of depreciation in its calculation.

EBITDA is popular indicator of great relevance, but it should always be used in conjunction with other indicators to help your business achieve the best results possible.