How to Calculate EBITDA

Want to finally understand EBITDA—without all the jargon? In this video, Steve breaks it down in a clear, simple way that actually makes sense.

You’ll learn what EBITDA really means, why it matters, and how to calculate it step by step using real examples. Whether you’re running a business or just looking to boost your financial IQ, this is your go-to guide for mastering one of the most important metrics in business.

TRANSCRIPT:

Hey, it's Steve. In this video, I'm gonna walk you through how to compute EBITDA from the very top. I'm going to abbreviate things so you can understand this really quickly.

First, we have revenue. Revenue represents the top line of a business or the sales of the organization. So every time a company sells its products and services to its end users, it hits revenue.

Underneath revenue, we have the cost associated with producing that revenue, which may include material costs, direct labor, subcontractor costs, and all other direct and indirect costs, like I said, associated with delivering products and services into the hands of customers.

So if we take revenue minus cost of goods sold, we end up with gross margin or gross profit. This measures a company's ability to price its products and services effectively, sell those products and services to customers, incur the cost, and then ultimately make money in the process.

Underneath gross margin, we have OPEX, which stands for operating expense, also known as the overhead of a business. Now, underneath OPEX, there are subcategories, such as selling general and administrative expenses, such as marketing costs, general administrative payroll, professional fees, insurance, travel, meals, and entertainment, occupancy expense— all costs associated with running the business are captured here in SG&A.

Oftentimes, organizations will also break out depreciation in amortization underneath OPEX.

Remember, if you go buy a piece of equipment or a truck or something for your business, you can't just write it off in a given year. You can't just record the entire expense in OPEX according to GAAP. Instead, you have to depreciate it over a useful life.

In other words, if an asset is gonna provide future economic benefits for a business and it has a useful life greater than one year and it meets a certain threshold, which is typically between 2,000 or 5,000 and above, then you're gonna capitalize that, record it on the balance sheet, and then each year, you're gonna depreciate it and record a portion of that expense on the income statement.

The only difference between depreciation and amortization is that you depreciate tangible assets and you amortize intangible assets. So that's broken down here underneath OPEX.

Typically, some companies, they may record depreciation and amortization up above in cost of goods sold. But for this example, I'm gonna keep it under OPEX. And then we end up with operating profit.

The key word here is operating. This is the amount of profit the company makes through normal operations of its business.

Underneath operating profit, we have other income and expense. These are just other items that are not a part of normal operations, the normal course of business.

For example, you may have interest income, and unless you're a bank in the business of earning income off interest, you're gonna record interest income down below in other income.

If you have a gain on the sale of a piece of equipment, for example, that's extraordinary, non-recurring, that goes down here in other income.

You may also have interest expense. That's not a part of normal operations. Or you have a loss on a piece of equipment or some other non-recurring, non-operating item that's gonna hit down here in other expense as well.

All right, so after we account for those, we have net income. Now look, I'm keeping things really high level. Like I said, if you're a DBA or an LLC or an S corporation, your entity is considered a disregarded entity and it doesn't pay taxes like a C corporation.

So I'll just stop here at net income because I'm trying to get you to EBITDA.

Now EBITDA stands for Earnings Before Interest, Tax, Depreciation, and Amortization. And the reason why it's valuable is because if you're comparing one company to the next, it basically ignores their capital structure and decisions they make in their business related to CapEx, to capital expenditures.

In other words, one company may be heavily invested in capital expenditures. They buy a lot of trucks and equipment and then they depreciate it differently from another business. Maybe they use an accelerated depreciation method versus a straight line method.

Or another business, they may be capitalized by a lot of debt and another business has a lot of equity. When you take out interest, interest income and expense, and you ignore depreciation and amortization, it gives you a profit number that is more comparable on an apples to apples basis. That's why EBITDA is helpful.

Now, EBITDA is not the same thing as cash flow. Don't fall into that trap of believing that. Instead, just keep it at that definition: earnings before interest, tax, depreciation, and amortization.

Now, some will think operating profit equals EBITDA. And sometimes that is true. It just depends where depreciation and amortization sit.

In this example, depreciation and amortization are sitting up above in OPEX. So we have to add that back.

So let's just put some numbers to this off to the side. Let's say revenue is $1,000. Cost of goods sold is 600. I take 1,000 minus 600, I arrive at 400 in gross margin.

And then OPEX, let's just say this is 200 in SG&A. It's $100 in depreciation and amortization, which gets us to an operating profit of $100, which is $400 minus 200 minus 100. And that's our operating profit here.

Other income we have at 10, and net income we have at 90. This is considered the bottom line here, net income.

Okay, but for EBITDA, we want to ignore interest, right, and taxes. And taxes aren't included in this example because I explained why just a minute ago.

But interest is—it's down below in other income. So we don't wanna use net income or then we're gonna have to add back this line item and then it gets all weird.

So let's just start with operating profit here of $100. Now, that's fine, but we need to add back depreciation and amortization, like I said, because it's being subtracted up above.

So if I take this and add it back, then our EBITDA added together is right here, 200 bucks.

All right? So that's how you compute EBITDA in a business. Very simply, you just have to understand where interest and depreciation and amortization is buried within the financials. And then you got this.

If this was helpful, can I get a yes in the comments box below? Also, if you have other feedback or you want me to produce other content, I would love to understand what you're looking for. You can drop that below as well in the comments box.

And until next video, take care of yourself. Cheers.