EBITDA –
simply explained

Key facts at a glance:

• A business metric that excludes interest, taxes, and depreciation/amortisation.

• Enables a more objective valuation regardless of financial structure, industry, and location.

• In the rating process, EBITDA can be used to determine what additional burden from interest and principal repayments the company can bear.

What Does "EBITDA" Stand For?

The abbreviation stands for "Earnings before Interest, Taxes, Depreciation and Amortisation". EBITDA is intended to help evaluate companies more objectively than is possible through pure profit alone: by excluding interest, taxes, and depreciation from the result, a company's profitability can be better compared with others — regardless of financing structure, industry, or country of incorporation.

EBITDA as a business metric is designed to help evaluate companies more objectively than through pure profit. By excluding interest, taxes, and depreciation from the result, a company's profitability can be better compared with others — regardless of financing structure, industry, or country of incorporation.

The actual operational strength of a company is often distorted by taxation, financing structure, accounting practices, and depreciation methods and periods. When one wishes to assess a company's economic viability internationally and across sectors, EBITDA is usually the metric of choice.

How Is EBITDA Calculated?

The metric can be determined within the framework of a company's profit and loss statement (P&L). The calculation of operating profit before interest, taxes, and depreciation is in principle not overly complex: interest and depreciation items are simply added back to the regular pre-tax operating result in the P&L.

Caution is required, however, with the term "interest". In EBITDA, this is interpreted very broadly: it ultimately includes all costs from all types of financing as well as income from financial investments.

The so-called EBITDA margin also provides a way to determine a company's return on sales:

EBITDA margin in percent = EBITDA / Revenue × 100

EBITDA in Credit Rating

EBITDA does not only help to better compare a business operationally with others. For lenders, too, this metric often plays a decisive role.

In the rating process, EBITDA can quickly determine what additional burden from interest and principal repayments the company can still bear. To do this, the costs of existing financing and taxes are simply deducted from EBITDA.

In this way, a bank can, for example, assess the debt service capacity of the applicant — ultimately, whether they will be able to cover their financing costs in the future.

Limitations of EBITDA

There is also criticism of the "Earnings before Interest, Taxes, Depreciation and Amortisation" model. As a metric that presents an idealised picture of profitability, the explanatory power of EBITDA is sometimes called into question.

After all, factors such as a high demand for machinery, buildings, or complex software, as well as heavy tax and interest burdens, do create significant costs that can put a company under pressure and thus also have an impact on its efficiency and profitability.

It is therefore particularly important in a credit process to pay attention to various factors and metrics when assessing risk.