What is EBITDA?
EBITDA stands for earnings before interest, taxes, depreciation and amortisation. It excludes taxes, financing costs and certain non-cash expenses.
In practical terms, EBITDA is a measure of a company’s operating profitability and the ability to pay its debts.
EBITDA aims to provide a clearer view of how a business performs purely from its operations, before the effects of:
- capital structure (debt vs equity);
- the tax jurisdiction of the company; and
- accounting policies relating to depreciation or amortisation.
This makes it particularly useful when:
- comparing companies (especially across different jurisdictions);
- assessing credit worthiness;
- assessing acquisition targets; and
- valuing businesses.
How to calculate EBITDA
There are two common approaches:
1. Starting from operating profit (EBIT):
EBITDA = Operating Profit + Depreciation + Amortisation
2. Starting from net profit:
EBITDA = Net Profit + Interest + Taxes + Depreciation + Amortisation
Worked example
Assume a company reports:
Net profit: £100,000, interest: £20,000, taxes: £30,000, depreciation: £25,000, amortisation: £5,000
EBITDA = 100,000 + 20,000 + 30,000 + 25,000 + 5,000 = £180,000
This £180,000 represents the company’s earnings from core operations before external and non-cash factors.
EBITDA margin and EBITDA margin formula
The EBITDA margin shows EBITDA as a percentage of revenue. It is a key indicator of operational efficiency.
EBITDA margin formula: EBITDA Margin = (EBITDA ÷ Revenue) × 100
What the margin shows
The EBITDA margin demonstrates how much operating profit a company generates for every pound of revenue.
Example:
EBITDA: £180,000
Revenue: £900,000
EBITDA Margin = (180,000 ÷ 900,000) × 100 = 20%
This means the business converts 20% of its revenue into operating earnings before non-operating costs.
EBITDA vs Gross Profit
While both are profitability metrics, they measure different things:
Gross profit:
Gross Profit = Revenue – Cost of Goods Sold (COGS):
This focuses on production efficiency.
EBITDA:
- takes into account operating expenses (e.g. overheads, salaries); and
- provides a broader view of operational performance.
Key distinction
Gross profit stops at direct costs, whereas EBITDA reflects overall operating profitability.
What is a good EBITDA?
There is no universal benchmark, as “good” EBITDA depends heavily on industry, business model and growth stage. Context is critical as capital-intensive industries often have lower margins than asset-light businesses.
What does your EBITDA tell you?
EBITDA provides insight into:
- operational efficiency – how effectively a business converts revenue into profit (from its day-to-day operations);
- comparability – enables benchmarking against other companies (especially those in the same industry;
- debt servicing ability – often used by lenders to assess the company's repayment capacity; and
- valuation basis – commonly used in EBITDA multiples (e.g. 5× EBITDA).
What is adjusted EBITDA?
Adjusted EBITDA modifies standard EBITDA to exclude one-off or non-recurring items which are beyond the traditional "add backs" referenced above.
Typical adjustments can include restructuring costs, legal fees and owner-specific expenses.
Adjusted EBITDA aims to reflect the “true” maintainable earnings of a business, which is especially important in M&A transactions and business valuations. However, adjustments must be scrutinised carefully, as overly aggressive adjustments may inflate perceived profitability.
Summary
EBITDA is a valuable metric for assessing a company’s operational performance and comparing businesses on a like-for-like basis. It strips out financing, tax and accounting variables to focus on core profitability, making it central to valuations and some transactions.
However, its usefulness depends on careful interpretation. It should be considered alongside other metrics to provide a complete financial picture. For businesses considering strategic decisions such as restructuring, acquisition or exit, EBITDA can play a key role in valuation.
You may also find it helpful to explore related topics such as business valuations on dissolution and preparing your company for sale, which examine other broader factors in situation requiring company valuations.
Is a 20% EBITDA good?
In some sectors, a 20% EBITDA margin could be considered strong, indicating efficient cost management and solid operating performance. However, the benchmark varies by industry. For example, what is strong in retail may be average in software.
Why is EBITDA misleading?
EBITDA can be misleading because it ignores capital expenditure requirements (i.e., it does not account for the cash required to maintain assets); and excludes debt costs (interest, this can make highly leveraged companies appear healthier than they are).
A company with strong EBITDA may still struggle with cash flow or high debt levels, so it should never be viewed in isolation.
What is the debt to EBITDA ratio?
A debt to EBITDA ratio measures a company's ability to pay off its debt. A high ratio may indicate that the company's debt is too heavy a financial burden.
Is EBITDA the final profit?
No. EBITDA is not the final profit. It is a preliminary measure that excludes several real costs. Final profit (net profit) accounts for operating expenses, interest, taxes, depreciation and amortisation.