While a company’s sales, also known as revenue, often get a great deal of attention from the public, business owners, managers, investors and lenders pay particularly close attention to another key metric, EBITDA. That’s an acronym for “earnings before interest, taxes, depreciation and amortization.” It is a more nuanced tool than revenue and can illuminate how well or poorly cash flow is generated from operations. Here’s what to know about revenue and EBITDA. If you want help understanding how a firm’s EBITDA impacts its investment potential, consider working with a financial advisor.
Revenue, which is always reported on a business income statement, consists of all income generated by business activities – before expenses – during an accounting period. It also includes all money a company is owed.
There are different sources of revenue. It may come from sales of products, from fees charged for services, rent and commissions. Other income sources include dividends on securities owned by the company and interest on money it has loaned. Any money brought in by business activities is revenue, which is generally reported quarterly and annually.
EBITDA, which is not required to be included in an income statement, focuses on the operating performance of a business. In particular, it shines a light on the business’s ability to generate cash flow from its operations. It does this by adding back to the net income figure expenses that are not directly tied to operations. The expenses for depreciation and amortization are non-cash expenses. That is, they are recognized as costs on a firm’s income statement but do not require the outlay of any actual money. Interest and taxes do require payment in cash, but are non-operating expenses not directly affected by the business’s primary activities.
More than one formula can be used to figure EBITDA. One that is widely used begins with the net income, which is the item on the bottom line of the income statement. Then it adds back to it the entries for taxes, interest, depreciation and amortization. For instance, if a company had $100,000 in net income and reported owing $20,000 for taxes, $15,000 for interest, $10,000 for depreciation and $5,000 for amortization, the formula would look like this:
EBITDA = net income $100,000 + taxes $20,000 + interest $15,000 + depreciation $10,000 + amortization $5,000
EBITDA = $100,000 + $20,000+ $15,000 + $10,000 + $5,000
EBITDA = $150,000
In this case the company’s EBITDA for the period would be $150,000.
Revenue vs. EBITDA: Uses
While cash is often described as the lifeblood of any business, revenue is arguably more important, since without revenue there can be no cash flow. Revenue is not the same as cash, however. One key distinction is that revenue is reported as it is accrued rather than as cash is received. That is, when a business books a sale to a customer, it’s added to revenue even if the customer won’t pay until later.
As the top line on an income statement, revenue is very important to a business’s prospects. If revenue is shrinking, it is likely to create pressure on net income.
EBITDA, which is often used as a substitute for a cash flow number, can be calculated by investors and lenders to estimate how well a company will be able to pay its bills and maintain or increase net income. EBITDA can be employed to value a business before sale. Business managers may compare their companies’ EBITDA to the EBITDA figures reported by similar firms to assess their own performance. EBITDA is particularly useful for analyzing companies that are capital-intensive. That’s because the heavy investment required of capital-intensive businesses can result in taking on large amounts of debt.
Investors and lenders, in particular, favor EBITDA over net income because it is less susceptible to manipulation by business managers using accounting and financial manipulation. It pares away the factors owners and managers have discretion over and reveals the underlying operational health of the business.
The Bottom Line
Revenue and EBITDA are both widely used to evaluate a company’s financial health and performance. Revenue is the all-important top line on a financial statement, representing income generated by the company’s sales activities before expenses as well as money it is owed. EBITDA starts at the bottom of the income statement with net income and adds back expenses that are more subject to managers’ discretion to arrive at a more accurate look at a business’s ability to generate cash.
Tips for Investing
Consider working with an experienced financial advisor if you are looking at revenue and EBIDTA to assess a business’s performance and strength. Finding the right financial advisor who fits your needs doesn’t have to be hard. SmartAsset’s free tool matches you with financial advisors in your area in five minutes. If you’re ready to be matched with local advisors who will help you achieve your financial goals, get started now.
Besides EBITDA, another important metric is EBIT, which stands for earnings before income and taxes. The fundamental difference between the two is that EBITDA adds back in depreciation and amortization, whereas EBIT does not. EBIT will tell you how well a company can do its job, while EBITDA will estimate what kind of cash spending power a company can have.
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