What is Ebitda? Ebitda calculation formula and illustrative example

EBITDA is a popular concept in business and is often used by administrators to measure pre-tax profits and depreciation losses. So what is EBITDA ? How is EBITDA calculated? To better understand this index, please join 1C Vietnam to learn about the article below!

1. What is EBITDA?

What is EBITDA index ? Simply put, EBITDA is a financial index used to measure a business's ability to generate profits from its core business processes. EBITDA does not take into account factors such as income taxes, interest on debt payments, depreciation and amortization of the business's assets. This indicator helps administrators focus on actual profits and business results.

EBITDA is an acronym of 6 English letters, with the following specific meanings:

• Earnings Before Interest: Profit before taking into account costs related to loan interest.
• Taxes: The amount of money businesses must pay to tax authorities.
• Depreciation: The loss of value of tangible fixed assets such as the wear and tear of equipment and machinery during use.
• Amortization: The net decrease in value of intangible assets such as patents and trademark rights over the course of use.

2. How is EBITDA calculated? Illustration

After grasping the concept and understanding what EBITDA is , administrators need to know how to calculate this index to be able to apply it in practice. Below is the detailed EBITDA calculation formula:

For example: Enterprise X has the following information for 2024:

• Profit after tax: 100 million VND
• Corporate income tax: 20 million VND
• Depreciation cost: 10 million VND
• Loan interest expense: 10 million VND

Based on the EBITDA calculation formula:

So based on the above formula, it is possible to calculate the EBITDA target of business X in 2024 to be 140 million VND.

3. The role of EBITDA in business

EBITDA is an important indicator in business. So specifically what role does this index play for investors and businesses? Find out in detail below.

3.1 For investors

Based on the index of income before taxes, interest and depreciation, investors will determine which businesses are operating well to decide to invest. Besides, according to the EBITDA formula, investors can exclude items such as depreciation, rent, and interest to calculate the business results of the business more accurately. From there, investors can give an overview of the company's financial situation.

3.2 For businesses

On the business owner's side, EBITDA helps administrators grasp important financial indicators as well as know whether the company's business situation is really growing or not to come up with adjustment plans. In particular, for businesses with large income tax differences, EBITDA will help administrators properly assess development potential, thereby making more optimal choices.

4. When to use EBITDA index?

The EBITDA index is used by administrators in many different situations to evaluate and measure the business performance of the enterprise. Here are some specific cases:

• Used in industries with large asset values: For manufacturing industries with large asset values, scale and density, depreciation is often high. Then the EBITDA index will be applied to create a financial report, helping to convince and create trust with investors.
• Application in EV/EBITDA valuation model: EBITDA index is very useful for valuation cash flow models or EV/EBITDA models. Many businesses even use this index as a substitute for cash flow during operations.
• Compare and analyze businesses: Businesses can use EBITDA to analyze different pricing models between businesses such as EBITDA Margin, EBITDA/Depreciation costs, EBITDA growth rate, EBITDA/Costs interest,...
• Long-term comparison and average: EBITDA index is the basis for comparing business performance over a period of time compared to the average company in the industry. This helps investors have a more accurate perspective on business performance over time.

5. Some myths about EBITDA

EBITDA is a popular index used by many businesses. However, if you do not clearly understand what EBITDA is , administrators may misunderstand and miscalculate, affecting the recognition of business results. Specifically:

• EBITDA as a substitute for cash flow: Many people believe that EBITDA can be a measure of cash flow because the EBITDA index ignores factors such as taxes and interest rates. However, in reality, cash flow includes changes in working capital, finance, cash flow from business activities and investments. While EBITDA only reflects the ability to generate profits from core activities. This index cannot replace and evaluate the company's comprehensive cash flow.

• EBITDA represents operating performance: EBITDA can measure the ability to generate profits without being affected by factors such as taxes, loan interest rates, and depreciation. But this index does not fully reflect all aspects of business activities. Some factors may not be accurately assessed such as debt repayment ability, working capital management or general financial performance of the business.

6. Notes when using EBITDA index

When applying EBITDA in practice, businesses need to keep in mind a few things below:

• Understand what EBITDA is: This is an index that reflects profits before calculating interest factors, depreciation, taxes and amortization fees. Understanding the true meaning of EBITDA will help businesses apply it more effectively and avoid unnecessary myths.
• Combined with other indicators: EBITDA alone is not enough to reflect the business situation of the enterprise. Therefore, it is necessary to coordinate EBITDA with other indicators such as ROE, ROA or free cash flow, to have a more comprehensive view of the financial situation and performance of the business.
• Consider industry and business cycles: Administrators can make EBITDA comparisons between businesses based on business cycles and provide specific context when performing calculations to ensure more accurate results.
• Consider adjustments: Businesses or investors need to check to see if any adjustments have been made to create a higher EBITDA index. This is necessary for transparent and accurate results as well as effective decision making.

7. Distinguish between EBITDA and Ebit ratios

EBITDA is often confused with another metric, EBIT. At first glance, these two indicators have certain similarities, but they are used for different purposes. Let's distinguish with 1C Vietnam through the detailed differences below:

• Meaning: EBIT is an index that measures a company's core business performance before interest rates and taxes. EBITDA is an index that reflects the same meaning but excludes two additional factors: depreciation and amortization fees.
• Calculation formula
  • EBIT = Profit before tax + Interest expense
  • EBITDA = EBIT + Depreciation
• Purpose: EBIT is used to evaluate the performance generated from business activities as well as compare with businesses in the same industry. Meanwhile, EBITDA is used to value a business, evaluate its financial management ability and growth.
• Accuracy: The accuracy of EBIT is lower than that of EBITDA because it does not exclude depreciation and amortization charges.

This article summarizes the concept of EBITDA , calculation formula, role and notes when using in practice. EBITDA is an important index with great significance and cannot be ignored in the process of recording business results of an enterprise. Hope your business has more useful information. If you have any questions, please contact 1C Vietnam for answers.