Earnings Before Interest, Taxation, Depreciation, and Amortization (EBITDA) is a long acronym that can help answer an important question: What is your company’s core profitability and operating efficiency, independent of capital structure, tax rates, and non-cash accounting items?
EBITDA focuses on your company’s earnings from regular operations, making the metric a useful indicator of your firm’s ability to generate profit from core business activities. The formula for calculating EBITDA is EBITDA = Operating Income + Depreciation + Amortization. A healthy EBITDA is generally considered to be at least two times a company’s interest expense, although the definition varies by industry, company size, growth stage, and capital structure.
Nue’s cloud-based financial planning and analysis (FP&A) software, designed specifically for government contractors (GovCons) and other project-based businesses, now prominently displays EBITDA on the dashboard’s income statement…
…with more details displayed under the Enterprise Value Calculator tab…
Your Creditors, Investors, and Executives are Watching
While EBITDA has its limitations (see below), it can serve as a key indicator of your firm’s financial health for your own management and those you do business with:
- Your leadership can monitor EBITDA to assess the performance of different business units minus the effects of financing and accounting choices on operating results. Both management and investors can also evaluate the effectiveness of strategies designed to improve performance.
- Investors can use EBITDA to measure your firm’s operational efficiency and profitability as they make investment decisions. They can assess, for example, whether the size of their investment is commensurate with your company’s earning capacity. For firms that are not yet profitable at the net income level, EBITDA can demonstrate positive cash flow and operational strength, both of which are appealing to investors.
- Creditors and investors often use EBITDA as a rough cash-flow proxy, since the metric excludes non-cash expenses. This focus on operational performance can be especially helpful in industries such as telecommunications, manufacturing, and energy, where significant investments in fixed assets result in high depreciation and amortization expenses. EBITDA helps focus on the core operational profitability without these non-cash charges.
- Lenders and credit analysts use EBITDA to evaluate a company’s ability to generate sufficient earnings to cover debt obligations and other fixed charges. The higher the EBITDA, the stronger the indication that a firm has the capacity to manage and repay debts.
- EBITDA allows for an apples-to-apples comparison between companies because the metric excludes the effects of financing and accounting decisions. This is especially useful in industries where companies often have different capital structures, tax situations, or asset bases.
EBITDA Has Its Limits
Despite its usefulness in analyzing a company’s operational performance and comparing it with other firms, EBITDA has its limitations, especially if a comprehensive financial evaluation is in order:
- EBITDA is not a standardized Generally Accepted Accounting Principles (GAAP) measure. Companies may calculate EBITDA differently, leading to inconsistencies among comparisons.
- By definition, EBITDA does not account for four of the most important costs of running a business (interest, taxation, depreciation, and amortization), which can be significant.
- Companies may EBITDA to disguise other negative aspects of their financial health, particularly if net income is low.
The bottom line is that EBITDA can provide your GovCon with a clearer view of profitability without capital expenses. Contact our team for a free demonstration at your convenience of Nue’s FP&A capabilities, including the new EBITDA calculation.