Calculating earnings before interest, taxes, depreciation and amortization -- EBITDA -- is essential when making decisions regarding stock sells or purchases. EBITDA will provide you with the net income for a business based on the business's service or product. EBITDA gives investors an indication of the company's financial performance, according to Stanford University. EBITDA negates the impact of financing and accounting decisions that can make a company look more, or less, profitable. While the length of the acronym makes it look like the calculation should be difficult, the acronym is longer than the formula for the calculation.
1. Inspect the income statement and find any listed taxes, interest, depreciation and amortization together. Be aware that some companies list amortization and depreciation as one item and some consolidate interest expenses and income into one category called "net interest." Look in the statement's notes for the net interest breakdown to discover the interest expense.
2. Locate the company's net income at the bottom on the statement.
3. Add the company's interest and tax expense to its net income to discover the earnings before interest and taxes (EBIT). For example, if the company's net income is $1.5 million, and its interest expense is $100,000 and its tax expense is $200,000, it has an EBIT of $1.8 million.
4. Add the company's depreciation and amortization to the EBIT to discover the EBITDA. For example, if the company's depreciation expense is $200,000 and its amortization is $100,000, its EBITDA is $2.1 million.
- Knowing the company's EBIT gives you the company's earnings including depreciation and amortization. If the company that you are researching has few capital expenditures for items such as buildings and vehicles -- depreciation -- or costs for items used to produce the company's goods -- amortization -- there will be little difference between the EBIT and EBITDA.
- EBITDA is most valuable when comparing companies in the same type of business because their operating costs should be similar. However, you will not get a complete picture of a company's cash flow using the formula.
- Accepting a company's published EBITDA instead of calculating it yourself can provide misleading data. Since EBITDA is not governed by accounting standards regulated by the Securities and Exchange Commission, companies can use their own discretion when deciding what data to use when calculating EBITDA.
- Do not use EBITDA as a research tool for companies with high levels of debt or those that consistently replace expensive equipment. EBITDA can make these companies look more financially sound than they are.
- While EBITDA excludes some non-cash items, it does not exclude all of them. These omissions can make a company look more profitable than it is.
Items you will need
- Income statement
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