EBITDA: meaning, formula and how to calculate it

EBITDA stands for earnings before interest, tax, depreciation and amortisation. It measures how much profit your business makes from its day-to-day operations. To get it, you add those four costs back to your net profit. That lets you compare performance without the effect of how you're financed, taxed or how your assets are accounted for.

All the figures you need are on your profit and loss statement (P&L). Here's how EBITDA works, how to calculate it and what it can and can't tell you about your business.

What does EBITDA stand for?

• Earnings: your profit

• Before

• Interest: what you pay on loans and other borrowing

• Tax: for a limited company, usually Corporation Tax

• Depreciation: the drop in value of physical assets, such as vans, machinery or computers, spread over their useful life

• Amortisation: the same idea for intangible assets, such as software licences, patents or goodwill

Depreciation and amortisation are non-cash costs. They spread what an asset cost you across the years you use it, rather than counting it all at once.

The EBITDA formula

There are two common ways to work it out. Both give the same answer:

EBITDA = net profit + interest + tax + depreciation + amortisation

EBITDA = operating profit + depreciation + amortisation

Net profit is what's left after every cost, including interest and tax. If your business makes a profit, your EBITDA will usually be higher than your net profit, because it adds those costs back.

How to calculate EBITDA

1. Find your net profit for the period on your P&L.

2. Add back the interest you paid.

3. Add back the tax charge.

4. Add back depreciation.

5. Add back amortisation.

6. The total is your EBITDA.

Here's how it works for Premier Manufacturing, an example business. This is its profit and loss statement:

On a P&L like this one:

• Sales minus cost of sales equals gross profit. Cost of sales includes the materials and labour that go directly into what you sell.

• Gross profit minus operating expenses equals operating profit. Operating expenses are the running costs of the business, including depreciation and amortisation.

• Non-operating items come next. Premier sold a machine during the year. It's a manufacturer, not an equipment dealer, so that sale counts as non-operating income. The net amount, £700, is added to operating profit.

• Interest and tax come off last, leaving net profit.

Add Premier's interest, tax, depreciation and amortisation back to its net profit, and its EBITDA is £56,200.

What is EBITDA margin?

EBITDA margin shows your EBITDA as a percentage of revenue. It tells you how much operating profit you make from each pound of sales.

EBITDA margin = (EBITDA ÷ revenue) × 100

Only count your normal trading income as revenue. Premier's gain on the machine sale isn't revenue, so its only revenue is £520,000 of sales.

Premier's EBITDA margin is £56,200 ÷ £520,000 × 100 = 10.8%. In other words, it earns nearly 11p of EBITDA for every £1 of sales.

What counts as a good margin varies a lot from one industry to another. It's most useful for tracking your own business over time, and for comparing yourself with similar businesses. A margin that rises year on year usually means sales are growing faster than costs.

Why EBITDA matters for your business

EBITDA focuses on the core of your business: making and selling, paying your team and getting paid. It leaves out costs that depend on how a business is set up rather than how well it trades:

• Interest depends on how much you've borrowed. A business funded by its owners' money pays little interest, while one funded by loans pays more.

• Tax can differ between two businesses with similar profits, for example if one is using losses from earlier years to reduce its tax bill.

• Depreciation and amortisation depend on how many assets a business needs and how it accounts for them.

That's why EBITDA is useful for comparing businesses. People who might buy or invest in a business often look at it alongside other measures. If two businesses each make £3 million of sales a year, the one with the higher EBITDA is usually generating more profit from its operations.

What EBITDA doesn't tell you

EBITDA is a useful measure, but it leaves a lot out. Keep these in mind:

• It isn't cash flow. It ignores money tied up in stock and unpaid invoices, and the cash you spend on new equipment.

• Debt still has to be repaid. High borrowing means higher interest and loan repayments, even though EBITDA leaves them out.

• Tax is still due. EBITDA ignores it, but your tax bill doesn't go away.

• Assets wear out. Depreciation is a non-cash cost, but replacing equipment costs real money.

• It isn't a standard measure in statutory accounts, so businesses can calculate it slightly differently. Check how a figure was worked out before you compare it with another.

EBITDA vs cash flow

Most businesses prepare their accounts on an accruals basis. That means you record income when you earn it and costs when you incur them, not when the cash moves. It gives a fairer picture of profit, but it can make EBITDA and cash flow look very different.

For example, say Premier buys £1,000 of materials in January and pays £2,000 in labour in February to make a piece of furniture. It delivers the furniture in March for £4,200. Under accruals accounting, Premier records the £4,200 sale and the £3,000 of costs in March. After other costs such as delivery, it makes a £700 profit on the sale.

That profit doesn't tell you when Premier actually paid its suppliers and staff, or when the customer paid. The cash could have left the business months before it came back in. To see your cash position, look at your cash flow statement, not your EBITDA.

EBITDA vs net profit vs operating profit

EBITDA FAQs

Is EBITDA the same as profit?

No. EBITDA is profit before interest, tax, depreciation and amortisation are taken off. Net profit is what's left after all costs, so it's usually lower than EBITDA.

Can EBITDA be negative?

Yes. A negative EBITDA means the business's day-to-day costs are higher than its revenue, even before interest, tax, depreciation and amortisation.

Is a higher EBITDA always better?

Usually it points to stronger operating performance, but not always. A business can have a healthy EBITDA and still struggle with cash flow or heavy debt, so look at it alongside your cash flow and net profit.

Why do buyers and lenders look at EBITDA?

It gives them a like-for-like view of how a business performs before financing and accounting choices. They usually look at it alongside other measures when they assess a business.

What's the difference between EBITDA and EBIT?

EBIT is earnings before interest and tax. EBITDA also adds back depreciation and amortisation, so it's the same as or higher than EBIT.

What to do next

Work out your EBITDA each time you produce your monthly or yearly accounts. Compare it with earlier periods to see whether it's rising or falling, and with similar businesses in your industry. Tools like QuickBooks can help you keep your profit and loss up to date, so the figures are ready when you need them.

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We hope this guide has made EBITDA easier to understand and use. For more on profit, cash flow and growing your business, explore our small business blog.