- What each letter stands for
- The formula, two ways
- A worked example
- Why people use it
- What EBITDA hides
- EBITDA, net profit and cash: a simple comparison
- EBITDA, operating profit and gross profit: don't mix them up
- Where to find the figures
- How a business improves EBITDA
- Adjusted EBITDA: handle with care
- Should a small business track EBITDA?
- Frequently asked questions
EBITDA stands for earnings before interest, taxes, depreciation and amortisation. Calculate it by adding those four items back to net profit, or by adding depreciation and amortisation to operating profit. It shows operating performance, not cash.
You'll see EBITDA in bank conversations, in business-for-sale listings and in investor decks. It sounds technical, but the idea is plain: it's a way to look at what a business earns from its day-to-day operations before some accounting and financing items get in the way.
What each letter stands for
- E, Earnings: the profit figure you start from, usually net profit.
- B, Before: you're adding these items back.
- I, Interest: what you pay on loans and other borrowing.
- T, Taxes: income tax or corporation tax on your profits.
- D, Depreciation: the accounting charge that spreads the cost of equipment and vehicles over their useful life.
- A, Amortisation: the same idea for intangible assets such as acquired software or intellectual property.
Depreciation and amortisation are accounting entries, not cash leaving your bank that month. Interest depends on how you've funded the business, and tax depends on where and how you're taxed. Taking them out gives a view of operating performance that is easier to compare across businesses.
The formula, two ways
There are two routes to the same answer.
- From the bottom up: net profit + interest + taxes + depreciation + amortisation = EBITDA
- From the middle: operating profit + depreciation + amortisation = EBITDA
Operating profit is the figure after cost of sales and running expenses but before interest and tax. If your profit and loss statement shows it, the second route is the quickest. If you need a refresher on how those statements fit together, my basic accounting terms guide covers the vocabulary.
A worked example
The numbers below are made up for illustration and don't include any currency. Imagine a small business with the following year.
| Line | Amount |
|---|---|
| Sales | 400 |
| Cost of sales | 160 |
| Running expenses, including depreciation of 20 | 120 |
| Operating profit (400 - 160 - 120) | 120 |
| Interest paid | 15 |
| Tax | 20 |
| Net profit (120 - 15 - 20) | 85 |
Now work out EBITDA both ways.
- From the bottom up: 85 + 15 + 20 + 20 = 140
- From the middle: 120 + 20 = 140
EBITDA is 140. Divide it by sales and you get an EBITDA margin of 35 per cent (140 divided by 400). That margin can be useful when you compare periods or businesses, but only if they calculate it the same way.
Why people use it
- Comparing businesses: two companies with different loans, tax situations or equipment age look more alike once you strip those out.
- Valuing a business: buyers and brokers often quote a multiple of EBITDA when discussing a price. The multiple varies a lot by industry and size, so treat any figure you hear as a starting point for questions.
- Lenders: banks sometimes use it to judge whether a business can cover its debt payments.
- Tracking operations: it helps you see whether the core business is improving, separate from financing decisions.
What EBITDA hides
This is the part that matters most for a small business owner. EBITDA can look healthy while the business struggles for cash.
- It ignores equipment you need to replace. Depreciation is a real cost of staying in business, even if it isn't a monthly payment.
- It ignores interest. A business loaded with debt can have strong EBITDA and still be in trouble.
- It ignores tax, which you still have to pay.
- It isn't cash flow. It doesn't show late-paying customers, stock you've bought or money tied up in the business.
A cash flow forecast shows what's really coming in and going out, and it's a better tool for staying solvent. EBITDA tells you about performance. Cash flow tells you whether you can pay the bills.
EBITDA, net profit and cash: a simple comparison
| Measure | Answers the question | Weakness |
|---|---|---|
| Net profit | What's left after everything? | Affected by accounting choices and financing |
| EBITDA | How well does the core operation perform? | Ignores interest, tax and the cost of replacing assets |
| Cash flow | Can I pay my bills this month? | Can swing because of timing, not performance |
EBITDA, operating profit and gross profit: don't mix them up
Gross profit is sales minus the direct cost of what you sold. Operating profit takes off your running expenses as well. EBITDA then adds back depreciation and amortisation. Each one answers a different question, and people sometimes use the labels loosely, so always ask which figure someone means before you compare numbers.
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Where to find the figures
Everything you need sits in your profit and loss statement and your notes to the accounts: sales, cost of sales, expenses, depreciation, interest and tax. If your bookkeeping is up to date, your software can produce these in minutes. If it isn't, fix that first, because EBITDA built on messy books is just a confident-looking mistake.
How a business improves EBITDA
- Raise sales without raising running expenses at the same pace.
- Improve gross margin through better supplier terms or smarter pricing.
- Cut waste in running expenses, such as unused subscriptions.
- Fix the things that quietly drain time, such as slow invoicing and rework.
Improving EBITDA by delaying essential maintenance or underpaying yourself doesn't build a better business. It just moves the problem to next year.
Adjusted EBITDA: handle with care
You may see 'adjusted EBITDA', where a business removes one-off costs or owner-specific expenses. There can be good reasons for this, such as a one-off legal bill. It can also be used to flatter the numbers. If you're buying or selling, ask for a list of every adjustment and the evidence behind it.
Should a small business track EBITDA?
If you're a sole trader or a small service business, it's rarely necessary. Your accountant will focus on profit, tax and cash. EBITDA becomes useful if you're planning to sell, raise finance, or compare yourself with similar companies. Good bookkeeping underpins all of it, and if you're choosing software to record your figures, see my guide to the best bookkeeping software for small business and my comparison of Xero vs QuickBooks.
Rules differ between countries, and accounting standards define profit measures in different ways. This is general information, not accounting, tax or investment advice. Speak to a qualified accountant about your own figures.
Frequently asked questions
What does EBITDA stand for?
Earnings before interest, taxes, depreciation and amortisation. It's a measure of operating performance before financing, tax and certain accounting charges.
How do you calculate EBITDA?
Add interest, taxes, depreciation and amortisation back to net profit. Or take operating profit and add depreciation and amortisation.
Is EBITDA the same as cash flow?
No. EBITDA ignores changes in working capital, replacing equipment, interest and tax, so a business can have strong EBITDA and weak cash.
Do small businesses need to track EBITDA?
Usually not day to day. It becomes useful when you plan to sell the business, raise finance or compare yourself with similar companies.
