How to Calculate EBITDA: Definition, Formulas and Examples

EBITDA Meaning

EBITDA stands for Earnings Before Interest, Taxes, Depreciation, and Amortisation.

Where:

Earnings	Net income before deductions
Interest	The cost of borrowing money
Taxes	Government charges on income
Depreciation	The allocation of a tangible asset’s cost over its useful life
Amortisation	The gradual expense of intangible assets over time

It provides a measure of a company’s core profitability without being skewed by their debt structure (debt or equity financing) or accounting adjustments.

Essentially, EBITDA strips away the costs of financing (interest), government taxes, and non-cash accounting charges (depreciation and amortisation), giving a clearer picture of how profitable a company’s core operations are.

For example:

A company with a lot of debt will likely have high interest expenses.
A company in a high-tax area will pay more taxes than one in a low-tax area.
A manufacturing firm might have large depreciation costs due to expensive equipment investments.

EBITDA ignores these factors to provide a pure view of financial performance.

EBITDA Formula

The formula for EBITDA is:

EBITDA = Net Income + Interest + Taxes + Depreciation + Amortisation

Alternatively, if you already have the operating income (also called EBIT, or Earnings Before Interest and Taxes), you can use this formula:

EBITDA = Operating Income + Depreciation + Amortisation

This is because the formula for operating income is:

Operating Income = Gross Profit − Operating Expenses

Operating Income = Revenue − Cost of Goods Sold (COGS) − Operating Expenses

Where:

Revenue: Total income earned by selling goods or services before any expenses are deducted.
Cost of Goods Sold (COGS): The direct costs of producing or purchasing the goods, such as materials and labour.
Gross Profit: Revenue minus the cost of goods sold.
Operating Expenses: The indirect costs of running the business, excluding cost of goods sold, like rent, utilities, salaries and marketing.

EBITDA Example Calculations

Let’s calculate EBITDA using the following scenarios:

Example 1 – Net Income Provided

Net Income	£500,000
Interest Expense	£50,000
Taxes	£100,000
Depreciation	£70,000
Amortisation	£30,000

Using the EBITDA formula:

EBITDA = Net Income + Interest + Taxes + Depreciation + Amortisation

EBITDA = £500,000 + £50,000 + £100,000 + £70,000 + £30,000 = £750,000

Example 2 – Calculating Operating Income from Gross Profit

Gross Profit	£800,000
Operating Expenses	£200,000
Depreciation	£100,000
Amortisation	£60,000

Firstly, we need to calculate the operating income:

Operating Income = Gross Profit − Operating Expenses

Operating Income = £800,000 − £200,000 = £600,000

Next, the EBITDA calculation would be:

EBITDA = Operating Income + Depreciation + Amortisation

EBITDA = £600,000 + £100,000 + £60,000 = £760,000

Example 3 – Calculating Operating Income from Revenue

Revenue	£1,200,000
Cost of Goods Sold	£500,000
Operating Expenses	£300,000
Depreciation	£200,000
Amortisation	£90,000

Firstly, we need to calculate gross profit:

Gross Profit = Revenue − COGS

Gross Profit = £1,200,000 − £500,000 = £700,000

Next, we need to calculate operating income:

Operating Income = Gross Profit − Operating Expenses

Operating Income = £700,000 − £300,000 = £400,000

Now we can calculate EBITDA:

EBITDA = Operating Income + Depreciation + Amortisation

EBITDA = £400,000 + £200,000 + £90,000 = £690,000

Adjusted EBITDA

Sometimes EBITDA will be adjusted to normalise earnings and make comparisons fairer.

These adjustments may include:

Legal settlements
Restructuring costs
Natural disaster impacts
One off severance payments
Stock based compensation
Impairment charges (goodwill, intangible assets)
Unrealised gains or losses on financial instruments

Continuing from Example 1 above, if a business incurred a one-time legal expense of £20,000, adjusted EBITDA would be:

Adjusted EBITDA = EBITDA + Non-Recurring Expense

Adjusted EBITDA = £750,000 + £20,000 = £770,000

Limitations of EBITDA

While EBITDA is a valuable tool, it is important to remember some of the drawbacks.

Excludes Debt Costs and Taxes

EBITDA does not reflect the actual financial obligations of a company as it doesn’t account for interest expenses or taxes.

Companies that hold a large amount of debt may appear more profitable than they actually are when purely looking at EBITDA margin.

Ignores Capital Expenditures (CapEx)

Depreciation and amortisation are excluded from EBITDA calculations, yet these expenses often represent substantial investments in capital assets.

In industries that require heavy capital expenditures, such as oil and gas, EBITDA can present an inflated view of profitability, as it doesn’t account for the significant costs involved in maintaining and purchasing physical assets.

Not a Measure of Cash Flow

EBITDA is not the same as cash flow, and relying solely on it can be misleading when looking at a company’s financial health.

Even a company with strong EBITDA may face significant financial challenges if its cash flow is poor.

Why Use EBITDA and Not Net Income

Imagine two companies, Company A and Company B, both operating in the same industry:

Metric	Company A	Company B
Operating Income	£500,000	£500,000
Interest Expense	£50,000	£0
Taxes	£100,000	£80,000
Depreciation & Amortisation	£70,000	£20,000

Using net income, Company A appears less profitable:

Company A: £500,000 – £50,000 – £100,000 – £70,000 = £280,000
Company B: £500,000 – £0 – £80,000 – £20,000 = £400,000

However, this analysis is misleading because it includes factors like interest expenses, taxes, and depreciation and amortisation, which are not directly related to the companies’ core operations.

Using EBITDA, we can focus solely on the company’s operational performance:

Company A: £500,000 + £70,000 = £570,000
Company B: £500,000 + £20,000 = £520,000

By using EBITDA, we see that Company A actually has a higher operational performance (£570,000) than Company B (£520,000), despite having higher non-operational costs like interest and depreciation.

EBITDA removes these variables and provides a clearer picture of how well each company is performing in its core business activities.