Earnings before interest, taxes, depreciation and amortization, or EBITDA, is a company’s net income with four charges added back to it: interest expense, income tax expense, depreciation and amortization. Like the income statement it starts from, it covers a stretch of time rather than a balance at one date. What separates it from almost every other figure on that statement is that it is a non-GAAP measure, so no accounting standard fixes what belongs in it, and the nearest thing it has to an official definition in the United States comes from securities-disclosure rules rather than from accounting ones.
The Formula and the Four Addbacks
The calculation runs upward from the bottom line rather than down the statement.
EBITDA = net income
+ interest expense
+ income tax expense
+ depreciation
+ amortizationEach addback reverses one of the subtractions that produced the starting figure, and that chain of subtractions is set out in net income.
Interest expense is the cost of money the business has borrowed for the period. Income tax expense is the period’s charge for income taxes, which can be small or absent in an entity whose income is taxed to its owners instead of to the entity, a split covered in C corp versus S corp. Depreciation is the periodic charge that spreads the cost of a tangible long-lived asset across the periods it is used, and amortization does the same for an intangible one. Those last two are allocations of money already spent rather than payments made during the period, which is why they are described as non-cash charges.
Say a company’s books for a year close on the amounts below, with each addback applied to the bottom line in turn.
Net income 96,000
Interest expense 14,000
Income tax expense 26,000
Depreciation and amortization 38,000
EBITDA 174,000Why EBITDA Is a Non-GAAP Measure
A non-GAAP financial measure is a numerical measure of a registrant’s historical or future financial performance, financial position or cash flows that does one of two things. It excludes amounts, or is subject to adjustments that have the effect of excluding amounts, that are included in the most directly comparable measure calculated and presented in accordance with GAAP in the statement of income, balance sheet or statement of cash flows, or their equivalents. Or it does the mirror of that, and includes amounts, or is subject to adjustments that have the effect of including amounts, that are excluded from that comparable measure (SEC Regulation G, section 244.101). EBITDA falls under the first of those two branches, because adding the four charges back removes amounts that net income includes. Whenever a registrant, or person acting on its behalf, publicly discloses material information that includes such a measure, the registrant must accompany it with the most directly comparable GAAP measure and with a reconciliation between the two (SEC Regulation G, section 244.100).
Regulation G supplies that framework without ever naming the acronym. The rule that names it is the filing-level one, which carves earnings before interest and taxes (EBIT) and earnings before interest, taxes, depreciation, and amortization (EBITDA) out of a prohibition on excluding cash-settled charges from non-GAAP liquidity measures, at Item 10(e)(1)(ii)(A) (17 CFR 229.10).
What the measure actually contains was left to staff interpretation. “Earnings” means net income as presented in the statement of operations under GAAP, and a measure calculated differently from the description in Exchange Act Release No. 47226 should not be characterized as EBIT or EBITDA at all (SEC Compliance and Disclosure Interpretations, Non-GAAP Financial Measures, Question 103.01).
Neither rule reaches a company that files nothing with the Commission. Both bind registrants, meaning companies with a class of securities registered under Section 12 of the Securities Exchange Act of 1934 or required to file reports under Section 15(d) of it, other than an investment company registered under the Investment Company Act of 1940 (SEC Regulation G, section 244.101, 17 CFR 229.10). A private company computing EBITDA answers to its lender or its buyer, not to the Commission.
Where EBITDA Shows Up in a Firm’s Work
It is not one of the subtotals a GAAP income statement produces, and a registrant may not put it there at all, because the rules bar presenting a non-GAAP financial measure on the face of the GAAP financial statements or in the accompanying notes (17 CFR 229.10). The subtotals that statement does carry are covered in the income statement, so whoever wants this figure builds it from the statements rather than reading it off them.
It appears instead wherever a deal or a loan is being priced. Lenders write covenants as multiples of it, letters of intent name it as the basis of an offer price, and quality-of-earnings work, the diligence that tests how repeatable a target’s reported earnings really are, turns on which adjustments to it are legitimate. Adjusted EBITDA is also the measure buyers price an accounting practice on, which is worked through in private equity in accounting firms.
What EBITDA Is Confused With
Net income. Net income is the figure after interest, taxes, depreciation and amortization have been taken out, and EBITDA is the same period with those four put back.
Operating income. Neither EBIT nor EBITDA equals operating income. Operating income would not be considered the most directly comparable GAAP financial measure for either of them, because those measures make adjustments for items that are not included in operating income (SEC Compliance and Disclosure Interpretations, Non-GAAP Financial Measures, Question 103.02). Anything non-operating in the period opens that gap.
Operating cash flow. EBITDA is not a cash measure. It inherits every timing difference in the accrual accounting figure it starts from, and it never touches the movement in receivables, payables and inventory that a cash flow statement has to add back or subtract to get from earnings to cash.
Adjusted EBITDA. The adjustments are discretionary and no standard fixes them, which is why staff guidance says a differently calculated measure must be retitled, as adjusted EBITDA is, and why such a measure is not exempt from the prohibition that EBIT and EBITDA are carved out of (SEC Compliance and Disclosure Interpretations, Non-GAAP Financial Measures, Question 103.01). One situation is excepted from that. Where a company’s credit agreement carries a material covenant on adjusted EBITDA, and management believes the agreement is material, that the covenant is a material term of it, and that information about the covenant is material to an investor’s understanding of the company’s financial condition or liquidity, the company may disclose the measure as the covenant calculates it in management’s discussion and analysis, the narrative section of a filing where a company explains its results and its liquidity (SEC Compliance and Disclosure Interpretations, Non-GAAP Financial Measures, Question 102.09). One limit that does bind a filer is the bar on smoothing an item as non-recurring when a similar charge or gain sits in the prior two years or is reasonably likely to recur within two years (17 CFR 229.10). Outside a filing there is no such limit, so two buyers can adjust the same books to two different numbers and both can defend the arithmetic.
EBITA. EBITA is a different measure, not a variant spelling. It adds back interest, taxes and amortization, and leaves depreciation charged against the result.
Common Questions
Yes. EBIT adds back only interest and taxes, so depreciation and amortization are still charged against it, and adding those two back as well is exactly what turns EBIT into EBITDA.
Warren Buffett called trumpeting EBITDA “a particularly pernicious practice”, because doing so implies depreciation is not truly an expense, in his chairman’s letter in the Berkshire Hathaway annual report for 2002 (Berkshire Hathaway, Chairman’s Letter). The objection is to the depreciation addback rather than to the arithmetic.
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