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Knowledge Bank
The knowledge bank gives you access to our knowledge on numerous financial topics. Use the menu on the left to find instant information on the subjects listed. If you would like information on an area that we have not yet covered, please let us know and we will create a page.
Below you can see an example of a knowledge bank page.
EBITDA
Financial Reporting
October 2009
EBITDA (Earnings before interest, tax, depreciation and amortisation) is often used as a measure of performance, both internally and externally. Depreciation and amortisation are added back to the operating profit because they are non-cash expenses – so we are looking at something closer to the cash profit.
Internally, management is often judged on EBITDA performance as the depreciation policy is set by the finance department and so is usually considered to be beyond the control of the operational management.
Externally, analysts will often compare companies on the basis of EBITDA to remove the impact of different depreciation policies of different companies across an industry, as illustrated below.
Remember, depreciation and amortisation are used to spread the cost of fixed (non-current) assets against profit over the period of time that is expected to benefit from the use of the assets. There is no cash involved – the cash goes out when the asset is purchased – the depreciation or amortisation is simply a notional accounting expense to match the cost with the profits.
Whilst EBITDA is useful for comparing profits without the “noise” of depreciation and amortisation, both of which require subjective judgement in deciding how long the assets will benefit the business, both depreciation and amortisation are a real cost of doing business and can be very significant for capital intensive businesses. For example, Railtrack, the company which owned the UK rail network during the 1990s, originally chose to depreciate its track over 100 years, arguing that it was constantly repairing and maintaining the network and so the track had a virtually infinite life. During this period, the company looked extremely profitable because so little depreciation was being deducted from profits. It transpired that the track was not being maintained to the required standards and that much of the network in fact needed replacing much sooner than Railtrack had thought. Clearly the depreciation policy had been suspect, as had the apparent level of profits.
| EBITDA is calculated as follows: |
Earnings before interest & tax (operating profit)
Plus Depreciation
Plus Amortisation
= EBITDA |
EBITDA is not generally shown on the face of the income statement as it is not defined under accounting standards or company law. However if a company is aware that EBITDA is a key measure for the analysts, it is often included as a measure in the results press release.
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