EBIDTA

What is EBITDA?

EBITDA is an acronym that stands for Earnings Before Interest, Taxes, Depreciation, and Amortization.

It’s a measure of corporate profitability that represents cash profit generated by company operations. In simple terms, EBITDA is your company’s net income (earnings) with interest, taxes, depreciation, and amortization added back in.

It’s a measure of corporate profitability that represents cash profit generated by company operations. In simple terms, EBITDA is your company’s net income (earnings) with interest, taxes, depreciation, and amortization added back in.

Is it EBITDA or EBIDTA?

This question gets asked frequently, probably because it’s all too easy to mix up those letters. But it’s definitely EBITDA. 

What's the difference between EBIT and EBITDA?

EBIT and EBITDA represent two ways of measuring a company’s profitability. While similar, there is an important distinction. Both formulas start by calculating earnings, interest, and taxes, but EBIT doesn’t account for depreciation and amortization like EBITDA. Which method you should use depends on your startup’s situation, with EBITDA often being preferred by companies with lots of fixed assets.  

Let’s breakdown EBITDA’s individual components

• Earnings is your company’s net income, AKA how much money your business makes over a defined period of time.
• Interest is the cost of financing your business through loans and is what you pay on top of the borrowed principal.
• Taxes are payments made to the government — local, state, or federal — based on factors like income, property, or capital gains.
• Depreciation and amortization represent the gradual decrease in the value of assets over time and the writing off of the asset’s initial cost. Depreciation typically pertains to tangible assets, like machinery or buildings, while amortization applies to intangible assets, like copyrights or patents.

Why does EBITDA matter? 

EBITDA is useful to startup founders because it paints a clear picture of the company’s value, demonstrating your firm's worth to potential buyers and investors. So, if you're meeting with a VC firm to pitch your startup, come prepared with the EBITDA — they'll probably ask for it. 
Additionally, EBITDA often gets used by established businesses whose leadership needs a raw indication of earnings and an understanding of the company’s overall value to inform essential business decisions. 

What is a good EBITDA margin?

Since EBITDA measures a company’s profitability, a higher margin is generally better. You’ll want to do research on what a realistic and ideal EBITDA is for companies in your industry vertical.

How about the B2B software industry?

Bear in mind that even with the SaaS space, the ideal EBITDA margin can vary based on factors like the size of the business or its growth stage. However, a commonly cited benchmark for a healthy EBITDA margin in the SaaS industry is 25–30%. 
OpenView, a VC firm that works in the B2B SaaS space, conducted a report in 2019 that supports those estimates while also revealing the median EBITDA margin for publicly traded SaaS companies was 25%.
View OpenView’s findings and download the full report.

Is a 20% EBITDA good?

Some companies calculate their EBITDA margin for a more realistic picture of their business' profitability. To determine the margin, divide your EBITDA by total revenue. An EBITDA margin of over 10% is considered good.

Is a high EBITDA always a good thing?

A higher EBITDA indicates better company performance overall and shows potential investors that your startup is financially less of a risk. So yes, a high EBITDA is always a good thing. 

Can EBITDA be negative, and what does that mean?

Companies can have a negative EBITDA, though you want to avoid that from happening. A negative EBIDTA value tends to signal that the business has trouble with profitability and has poor cash flow. 

How to calculate EBITDA

There are two formulas for calculating EBITDA — the first is based on net income and the second on operating income:
1. Net Income + Taxes + Interest Expense + Depreciation + Amortization
2. Operating Income + Depreciation + Amortization
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EBITDA Calculation Example
Imagine you run a SaaS startup that provides digital solutions for the real estate industry. You look at your latest annual earnings report and this is what you see: 

Net income: $7,000,000
Depreciation and amortization: $800,000
Taxes: $2,500,000
Interest expenses: $1,500,000
Operating income: $11,000,000

Using the first formula for EBITDA, we have:
EBITDA = $7,000,000 (net income) + $800,000 (depreciation and amortization) + $2,500,000 (taxes) + $1,500,000 (interest expenses) 

So, based on this example, the company’s EBITDA is $11,800,000

Using the second formula for EBITDA, we have: 
EBITDA = $11,000,000 (operating income) + $800,000 (depreciation and amortization)

Based on this example, the company’s EBITDA is also $11,800,000

How EBITDA differs from gross profit

EBITDA and gross profit are financial metrics that illustrate a company’s profitability by removing different items or costs. However, they measure profitability differently.

You calculate a company’s gross profit by subtracting the costs associated with making or providing its products and services from a company’s income.

Both gross profit and EBITDA are financial metrics that measure a company's profitability by removing different items or costs.

How EBITDA differs from net income

The main difference between EBITDA and net income is that EBITDA doesn't include certain expenses in its calculation, whereas net income accounts for all of them. As a result, EBITDA often provides a clearer picture of a firm's operating profitability, while net income can better represent a company's overall financial health.  

Common sources of confusion about EBITDA

EBITDA is a useful metric with which every startup founder should get familiar. But it has limitations and should be used alongside other financial measures to create a comprehensive picture of a company's financial health.

These are some of the ways people most commonly confuse or conflate what EBITDA can accomplish:  

• Exclusion of Expenses: While EBITDA measures a company's profitability because it starts with its revenue and subtracts operating expenses, it doesn't include all expenses, including interest, taxes, depreciation, and amortization. As a result, it may not provide a complete picture of a company's financial health.
• Not the Same as Cash Flow: EBITDA doesn't account for changes in working capital, capital expenditures, or other cash flows. A high EBITDA don't always have a strong cash flow.
• Manipulatable: EBITDA isn't a standardized accounting metric, so companies can exclude expenses to change the result
• Not a Substitute for Net Income: While EBITDA can provide valuable information about a company's operating performance, it doesn't account for all expenses like net income. Using EBITDA as a net income substitute all the time could create a false representation of a firm's overall financial health. 

EBITDA and Startups

Startups, like established firms, should use EBITDA to determine their profitability, assess their financial health, and attract investors. Conversely, startups that aren't familiar with EBITDA risk making poor financial decisions and losing out on investment opportunities.

• Operating performance. EBITDA allows startups to see how much money they are generating from their core business operations, without the influence of non-operating expenses like interest, taxes, depreciation, and amortization.
• Strategic decision-making. By looking at their EBITDA, startups can make informed decisions about resource allocation, like whether to invest in marketing or hire more employees.
• Valuation metric. Investors often use EBITDA as a basis for valuation. A high EBITDA indicates a profitable business, which can attract more investment.

Putting EBITDA into Action 

When it comes to EBITDA, you can’t deny its utility and usefulness within the startup space. Any founder who knows how to use it to keep a finger on the pulse of their company’s financial health is better positioned to succeed. At the same time, remember that this measure has limitations and isn’t the be-all and end-all of financial metrics. While it’s important, EBITDA is only one piece of the puzzle. 

For information on another vital financial metric for startups, read this article on burn rates.