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EBITDA vs net income has always been a hot topic. In many annual reports, companies like to highlight EBITDA. However, this figure tends to be misleading especially to a novice investor who has not learned the ropes of investment and financing terms as yet.
Earnings before interest, taxes, depreciation and amortization, also known as EBITDA, is considered to be a non-GAAP (Generally Accepted Accounting Principles) metric measurement that is used to evaluate the profitability of a company or organization.
The easiest method of calculating EBITDA is as follows:
EBITDA = Operating Revenue – Operating Expenses + Other Revenue
Operating expenses do not include taxes, interests and amortization, and hence the name EBITDA. Since the method is not as per GAAP, a company can calculate EBITDA as they want. In addition, EBITDA is not a measure for cash flow.
EBITDA basically lets an investor know how much a company would have made if it did not have to pay interest on its debts, taxes or take depreciation and amortization charges. The figure is basically an indicator of a company’s financial performance.
The truth of the matter is that companies have to pay interest, taxes, depreciation and amortization. This is where net income comes into play. Net income is nothing but net profit after the company has deducted all its expenses including operational expenses, salaries, interest payments, taxes, depreciation and amortization. Many people would consider net income to be the true earnings of a company.
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