What Is EBITDA in Accounting? Calculation, Formula, and Example

Ever wondered how investors quickly judge whether a business is truly profitable or just looks successful on paper? Financial statements can be complex, but some metrics cut straight to the heart of performance. One of the most widely used measures EBITDA, reveals how efficiently a company runs its core operations by removing the effects of financing and accounting adjustments.

That is why understanding EBITDA can change how you evaluate business performance. It helps compare companies, identify growth potential, and make informed decisions. This blog explains what it means, how it is calculated, and why it matters.

What is EBITDA?

EBITDA stands for Earnings Before Interest, Taxes, Depreciation, and Amortisation. It is a financial measure used to understand how profitable a company is from its core business operations. Focusing on operating performance, it shows how efficiently a business generates earnings from its main activities.

This metric excludes financing costs, tax environments, and non-cash accounting expenses such as depreciation and amortisation. By removing these factors, EBITDA provides a clearer view of operational performance and makes it easier to compare companies across different industries and financial structures.

EBITDA Formulas and Calculation

The EBITDA formula explains how operating profitability is measured by excluding financing costs, taxes, and non-cash expenses. This gives a clearer view of core business performance. There are two main methods to calculate EBITDA:

1) Net Income-based Formula (Most Common)

2) Operating Income-based Formula (Simpler Approach)

EBITDA can be calculated from net income or operating income by adding back depreciation and amortisation, along with interest and taxes where applicable. Both methods typically produce the same result when financial data is consistent, as each isolates operating performance.

To understand this better, let’s break down each component of EBITDA:

Earnings

Earnings usually refer to net profit, which is total revenue minus legitimate business expenses. It reflects the income a company generates from its normal operations before adjustments are made for non-operating or non-cash items.

Before

Before means certain expenses are excluded from the calculation. These items are added back to net profit so EBITDA focuses only on core operating performance, without the influence of financing, tax, or accounting adjustments.

Interest

Interest represents the cost of borrowing money, such as loans or debt repayments. It is added back because financing structures differ between companies, and these costs do not directly reflect operational efficiency or performance.

Taxes

Taxes are payments made to governments based on profits. Since tax rates vary by country, regulation, and timing, they are added back to ensure EBITDA reflects operating performance rather than tax policies or obligations.

Depreciation

Depreciation is the gradual decline in the value of physical assets such as machinery, buildings, or vehicles over time. It is a non-cash accounting expense, so it is added back to show true operating earnings.

Amortisation

Amortisation is the gradual reduction in value of intangible assets such as patents, licences, or copyrights. Like depreciation, it is a non-cash expense, so it is added back to reflect actual operating performance more clearly.

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EBITDA Use Cases

EBITDA helps analyse business performance, attract investors, and support strategic decisions by showing how efficiently core activities generate earnings. Once calculated, it can be used in several key ways, including the following:

1) Build More Reliable Financial Models:

It provides a solid base for cash flow forecasts, helping businesses create more accurate financial projections and performance models.

2) Assess Business Value for Sale:

EBITDA helps clearly present profitability and financial strength to potential buyers during mergers, acquisitions, or business sales.

3) Attract and Inform Investors:

Investors rely on EBITDA to compare companies within the same industry using a consistent measure of performance.

4) Measure Operational Efficiency:

By isolating core activities, EBITDA helps evaluate how effectively the business operates without external financial influences.

5) Benchmark Against Competitors:

Companies use EBITDA to compare performance with industry standards and assess their competitive position.

6) Support Strategic Decision-making:

Understanding operating performance helps guide expansion plans, budgeting, cost management, and long-term business strategy.

What are the Advantages of Using EBITDA?

EBITDA is widely used because it provides a clear and simplified view of operating performance by focusing on core profitability and removing external financial factors. Below are the main advantages of using EBITDA:

1) Focuses on Core Operating Performance:

By excluding non-cash expenses like depreciation and amortisation, as well as interest and taxes, EBITDA highlights how profitable a company’s main business activities are.

2) Supports Comparisons Between Companies:

It allows fair comparisons between companies in the same industry, even if they have different debt levels, financing structures, or tax environments.

3) Acts as a Proxy for Cash Flow:

Although not a true cash flow measure, EBITDA provides a quick indication of a company’s ability to generate cash from operations to meet financial obligations.

4) Widely Used in Business Valuation:

EBITDA plays a key role in valuation metrics, especially Enterprise Value (EV)/EBITDA, which is commonly used in mergers, acquisitions, and Investment Analysis.

5) Simplifies Financial Analysis:

It is relatively easy to calculate from financial statements, making it a practical and efficient tool for assessing financial performance.

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What are the Disadvantages of Using EBITDA?

While EBITDA helps assess operating performance, it can present an overly positive view of financial health by excluding key costs. Below are the main disadvantages of using EBITDA:

1) Ignores Capital Expenditure (CapEx):

EBITDA excludes spending needed to maintain or replace assets. In capital-intensive industries, companies may appear profitable even when large reinvestments are required to sustain operations.

2) Excludes Debt and Tax Obligations:

By removing interest and taxes, EBITDA does not show the full financial burden of borrowing or taxation. This can make heavily indebted businesses seem stronger than they actually are.

3)  Does Not Represent Actual Cash Flow:

EBITDA is not a true measure of cash flow because it ignores changes in working capital, such as inventory or receivables, which directly affect available cash.

4) Lacks Standardisation:

Since EBITDA is not governed by strict accounting standards, companies may calculate it differently. This reduces consistency and makes comparisons across organisations less reliable.

5) Can Be Misleading or Manipulated:

Some companies emphasise EBITDA to present stronger performance or mask underlying financial weaknesses, potentially misleading investors.

What is Next Twelve Months (NTM) EBITDA?

Next Twelve Months (NTM) EBITDA is a forward-looking estimate of a company’s EBITDA expected over the upcoming 12 months. Instead of measuring past performance, it forecasts future operating profitability based on projected revenue and expected expenses.

NTM EBITDA is commonly used by investors and analysts to assess growth potential, support business valuation, and evaluate financial performance in advance. It helps provide insight into how profitable a company is likely to be in the near future.

How to Calculate NTM EBITDA?

Next Twelve Months (NTM) EBITDA estimates a company’s expected operating earnings over the coming 12 months. It is based on projected financial data rather than historical results and is commonly used in valuation and financial modelling. To calculate NTM EBITDA, follow these steps:

Step 1: Project the NTM Revenue

Estimate revenue for the next 12 months using projections such as analyst forecasts, company guidance, and historical trends. Adjust for factors like seasonality, product launches, market conditions, or operational changes that may affect performance.

Step 2: Determine the Expected NTM EBITDA Margin (%)

Determine the expected EBITDA margin based on recent historical margins and future expectations. Consider changes in operating leverage, cost structure, economies of scale, or overall business conditions that may influence profitability.

Step 3: Get Ready for the Final Computation

Once projected revenue and the expected EBITDA margin are determined, NTM EBITDA is estimated by applying the margin to the forecasted revenue. If quarterly forecasts are available, it can also be calculated by adding the projected EBITDA for the next four quarters.

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Difference Between EBITDA and EBITA

EBITDA and EBITA both measure operating performance by excluding interest and taxes, but they differ in how they treat depreciation and amortisation. EBITDA excludes both depreciation and amortisation, giving a broader view of operating profitability and easier comparison across companies.

Earnings Before Interest, Taxes, and Amortisation (EBITA) excludes amortisation but includes depreciation, reflecting the cost of using physical assets. This makes it a more conservative measure, especially useful for asset-heavy businesses.

Example of EBITDA

The following example shows how the EBITDA formula works in practice using real financial figures:

Company Financial Data:

a) Revenue: £500,000

b) Operating Expenses: £300,000

c) Depreciation: £20,000

d) Amortisation: £10,000

e) Interest Expense: £15,000

f) Taxes: £25,000

Step 1: Calculate Net Profit:

Net Profit = Revenue − Expenses − Depreciation − Amortisation − Interest − Taxes

Net Profit = £500,000 − £300,000 − £20,000 − £10,000 − £15,000 − £25,000 = £130,000

Step 2: Add Back Excluded Items:

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

EBITDA = £130,000 + £15,000 + £25,000 + £20,000 + £10,000 = £200,000

Final EBITDA:

The company’s EBITDA is £200,000, showing its operating profitability before financing costs, taxes, and non-cash expenses.

Conclusion

Understanding financial performance becomes clearer when you focus on what truly drives business operations. EBITDA helps reveal operational efficiency by removing financing costs, tax effects, and non-cash accounting expenses. When used alongside other financial metrics, it offers valuable insight for comparing companies, assessing profitability, and making more informed business or investment decisions.

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