EBITDA Formula: How to Calculate It, a Worked Example and What It Leaves Out

The EBITDA formula, two ways

From the top: EBITDA = operating income (EBIT) + depreciation + amortisation
From the bottom: EBITDA = net income + interest expense + income tax + depreciation + amortisation

Operating income is on the income statement; depreciation and amortisation are on the cash flow statement for every company and on the income statement for some. The bottom-up route is the one to use when operating income is not clearly stated or when non-operating items sit between the two, and the two routes agree only when nothing else lies between operating income and net income, which is worth checking: a gain on a disposal or a currency loss will make them differ by exactly its amount. The how to read an income statement article covers where each line sits.

Worked example: Northfield Tools (illustrative)

Northfield Tools is the fictional industrial company used across these guides. On $1,500 million of revenue, $240 million of EBITDA is a 16% EBITDA margin, two points above the 14% operating margin because depreciation is a relatively small charge for this business. For a capital-heavy company the gap is far wider, and that gap is the whole reason to be careful with the measure.

What EBITDA is for

Three uses justify the measure. Comparing companies. Interest depends on how a company is financed, tax on where it operates, and depreciation on how old its assets are and how aggressively it writes them down; EBITDA removes all three, so two businesses can be compared on their operations alone. Sizing debt. Lenders lend some number of turns of EBITDA and test covenants against it, which the net debt to EBITDA article covers. Pricing deals. A buyer will refinance the debt, change the tax position and revalue the assets, so the profit that survives the transaction is EBITDA, and takeover prices are quoted as multiples of it; the EV to EBITDA article explains the multiple.

The same EBITDA, two different businesses

Imagine two companies, each with $240 million of EBITDA on $1,500 million of revenue. The first is Northfield, which depreciates $30 million a year and spends about the same keeping its plant current. The second runs a fleet of vehicles and depreciates $150 million a year, spending $160 million to replace them. Their EBITDA margins are identical at 16%. Their operating margins are 14% and 6%. Their free cash flow, before working capital, is roughly $210 million and $80 million. A lender looking only at EBITDA would size the same loan for both; an investor looking only at EBITDA would pay the same multiple for both; and the second company would be able to afford neither. This is the whole case for reading EBITDA beside operating income and free cash flow rather than instead of them.

The bridge from EBITDA to cash

EBITDA is sometimes described as a proxy for cash flow. It is a starting point for one. Harbor Foods, the other fictional company in these guides, shows the distance:

Less than half of Harbor's EBITDA reaches free cash flow, and every line in between is a real claim: the lenders, the government, the customers who have not yet paid, and the plant that must be replaced. The free cash flow formula article works the same bridge from the other end, and the how to read a cash flow statement article shows where each line is reported.

What EBITDA leaves out

• Capital spending. The depreciation it adds back is the accounting shadow of real spending on assets. A company that must reinvest most of its EBITDA to stand still has little of it to show for shareholders.
• Working capital. Growth absorbs cash into receivables and inventory; EBITDA does not notice.
• Interest and tax. Both are real and both are paid before shareholders see anything.
• Stock-based compensation. Usually added back in adjusted versions, though it dilutes every holder.
• Leases. Since lease accounting changed, part of rent sits below EBITDA as depreciation and interest, so lease-heavy companies report higher EBITDA than before for the same economics.

None of this makes the measure useless; it makes it a measure of operating profit before the cost of capital, which is precisely what it says it is. The error is to treat it as cash, or as the profit that belongs to shareholders. Operating income charges for the assets, as the operating margin formula article shows, and free cash flow charges for everything.

Adjusted EBITDA

Most companies also report an adjusted EBITDA that adds back restructuring charges, stock-based pay, litigation costs, acquisition expenses and other items management considers unrepresentative. Loan agreements often define their own version. The adjustments are the company's choice, and their value as information lies in the reconciliation table: when adjusted EBITDA runs far ahead of reported EBITDA year after year, the excluded costs are part of the business. Use the reported figure for comparisons and the adjusted one to understand what management wants you to see. The earnings analysis guide covers reading the reconciliation every quarter, and VALYSTR's company pages compute EBITDA from the filed statements rather than taking the company's adjusted figure.