EBITDA

What is EBITDA?

EBITDA is a company's result before interest, taxes, depreciation and amortisation. The abbreviation stands for Earnings before Interest, Taxes, Depreciation and Amortization. The taxes meant are taxes on profit, for a GmbH (German limited liability company) corporation tax and trade tax. Depreciation and amortisation spread the purchase price of assets such as machinery, computers or acquired software as an expense over the years of their use. EBITDA thus shows what the ongoing business earns, independent of financing, tax position and the timing of earlier investments.

For a rented-out holiday flat, this would mean: cleaning, utilities and agency fees are deducted from the rental income, while the loan interest, the tax and the annual loss of value of the furnishings initially stay outside.

The German Commercial Code (Handelsgesetzbuch, HGB) does not know the term, so EBITDA does not appear in the annual financial statements of a GmbH. It is derived from the income statement and used in valuations and share analyses, in purchase and loan agreements, in financial models and in monthly reporting. In the absence of a statutory definition, the definition in the document concerned applies, for example in the loan agreement or in the purchase price rules of a company purchase agreement.

Calculating EBITDA: derivation from the income statement

German GmbHs commonly structure their income statement under the nature of expense method (Section 275(2) HGB). From this scheme, EBITDA can be derived item by item:

1. Revenue (no. 1)
2. plus or minus increase or decrease in finished and unfinished goods, that is, in self-produced goods not yet sold (no. 2)
3. plus other own work capitalised (no. 3)
4. plus other operating income (no. 4)
5. minus cost of materials (no. 5) and personnel expenses (no. 6)
6. minus other operating expenses (no. 8)
7. minus other taxes (no. 16)

Three groups stay outside. First, the depreciation and amortisation of intangible assets of fixed assets and of tangible fixed assets (no. 7 letter a). Intangible assets are non-tangible values such as software, licences or patents. Second, the entire financial result, that is, income from participations, securities and interest, write-downs of financial assets and of securities held as current assets, and interest expenses (nos. 9 to 13). Third, taxes on income and earnings (no. 14).

Backwards, income taxes and depreciation and amortisation are added to net income for the year and the financial result is stripped out: a negative financial result is added, a positive one deducted. If it consists only of interest, the following applies:

Formula: EBITDA = net income for the year + income taxes + interest expense - interest income + depreciation and amortisation = EBIT + depreciation and amortisation

Questions of allocation

Three points are not regulated uniformly. Other taxes such as property tax or motor vehicle tax appear in the scheme only after the result after taxes but are economically operating costs and are usually deducted from EBITDA. Unusually high write-downs of current assets (no. 7 letter b), for example on unsaleable inventory, are added back by some definitions and not by others. Under the cost of sales method (Section 275(3) HGB), depreciation and amortisation are contained in cost of production, selling and administrative expenses. They must then be taken from the fixed asset schedule in the notes, which shows the development of fixed assets, or, for small companies, from the bookkeeping.

Variants: adjusted EBITDA, EBITDA margin, LTM and EBITDAR

• Adjusted EBITDA: reported EBITDA excluding one-off, non-operating and out-of-period items, for example transaction costs, severance payments or a non-market managing director remuneration. Details are explained in the entry adjusted EBITDA.
• EBITDA margin: EBITDA divided by revenue times 100%. It makes companies of different sizes comparable and shows whether growth goes together with rising or falling earning power.
• LTM EBITDA: the EBITDA of the last twelve months (Last Twelve Months). In transactions it is often the reference figure because the annual financial statements are often already months old at contract signing.
• Annualised EBITDA (run rate): a shorter period, for example the last quarter, extrapolated to twelve months. It reflects the current level of fast-growing companies better but is susceptible to seasonal fluctuations and is reviewed critically.
• EBITDAR: EBITDA additionally before rent and lease expense (Rent), in part also before restructuring costs. Retail, hospitality and aviation use it to compare companies with rented and owned premises or aircraft.

Influence of accounting on EBITDA

Capitalised own work

For internally generated intangible assets of fixed assets, typically self-developed software, there is an option to capitalise under Section 248(2) HGB. The company may therefore include development costs as an asset on the balance sheet (capitalise them) instead of booking them immediately as expense. Only the costs of the development phase may be capitalised, not those of research (Section 255(2a) HGB). If a company uses the option, the developers' salaries remain in personnel expenses. At the same time, income arises in the amount of the capitalised costs in the item “other own work capitalised”. The expense shifts into the later depreciation and amortisation, which stands below EBITDA.

EBITDA rises as a result, without anything changing in cash flows or business model. Buyers and investors therefore often strip out capitalised own work, above all when comparing with companies that book development costs immediately as expense.

Rent and leasing compared with IFRS 16

Under the HGB, rent and lease payments generally remain expense and reduce EBITDA as long as economic ownership lies with the lessor. In financial statements under the International Financial Reporting Standards (IFRS), by contrast, IFRS 16 applies. Under it, a lessee recognises most leases as a right-of-use asset and a lease liability, and depreciation and interest take the place of rent expense. The EBITDA of an IFRS reporter is higher for the same business, but the lease liability increases its net debt.

EBITDA in valuation, financing and transactions

In business valuation, EBITDA is the most widespread reference figure for multiples, that is, factors by which a result is converted into an enterprise value. The enterprise value results, in simplified terms, as EBITDA times EBITDA multiple. After deduction of net debt, that is, financial debt less liquid funds, the value of equity follows. Every euro of EBITDA thus acts on the purchase price with the factor of the multiple, which is why definition and adjustments are negotiated intensively.

In loan agreements, EBITDA is the basis of the financial ratios whose compliance the bank monitors (Covenants). Above all the dynamic debt ratio (leverage), the ratio of net debt to EBITDA, is widespread. When buyers or investors review the financial figures (financial due diligence), the sustainability of the reported EBITDA is at the centre (quality of earnings). What is reviewed is which items are one-off, which revenues recur and how strongly accounting options shape the result.

Limits of EBITDA

EBITDA is not a cash measure; it measures income and expense, not cash receipts and cash payments. Replacement and expansion investments are missing entirely, so it overstates the earning power of capital-intensive companies. Growing receivables and inventories tie up liquidity without touching EBITDA. Taxes and interest are real payments that are likewise missing. For the question of what actually flows to owners and lenders, operating cash flow and free cash flow are more meaningful.

Worked example: calculating EBITDA and EBITDA margin

The income statement of a software GmbH under the nature of expense method shows the following items (in thousands of euros). Income: revenue 10,000, own work capitalised 400, other operating income 100. Expenses: cost of materials 1,500, personnel expenses 5,200, depreciation and amortisation 600, other operating expenses 1,780 (including office rent 300). Financial result: interest income 20, interest expense 220. Taxes: income taxes 360, other taxes 20. Net income for the year 840.

First route, forwards from revenue:

• 10,000 plus 400 plus 100 = 10,500
• 10,500 minus cost of materials 1,500 = 9,000
• 9,000 minus personnel expenses 5,200 = 3,800
• 3,800 minus other operating expenses 1,780 = 2,020
• 2,020 minus other taxes 20 = EBITDA 2,000

Second route, backwards from net income for the year (other taxes remain deducted because they count as operating expense):

• Net income for the year 840 plus income taxes 360 = 1,200
• 1,200 plus interest expense 220 minus interest income 20 = 1,400 (EBIT); the negative financial result of minus 200 is thus added
• 1,400 plus depreciation and amortisation 600 = EBITDA 2,000

Both routes lead to 2,000; the EBITDA margin (EBITDA divided by revenue) is 20%. Without capitalisation of the development costs, the income of 400 would drop out; EBITDA would be 1,600, the margin 16%. At an assumed multiple of 8, these 400 correspond to a difference in enterprise value of EUR 3.2 million. Under IFRS 16, depreciation and interest would, in simplified terms, take the place of the office rent, and EBITDA would rise to 2,300. The same business can thus show an EBITDA between 1,600 and 2,300 depending on accounting, which is why the definition must be agreed before any comparison.

Distinctions: EBITDA, EBIT, operating cash flow and contribution margin

• EBIT: EBITDA less depreciation and amortisation. It takes the consumption of value of fixed assets into account and is the more meaningful result figure for capital-intensive companies.
• Operating cash flow: a cash measure that also takes account of taxes paid and the change in working capital, that is, the money tied up in receivables and inventories less open supplier invoices.
• Contribution margin: revenue less variable costs at product or customer level; it measures the contribution to covering fixed costs, not the result of the whole company.

Common mistakes

• Equating EBITDA with liquidity. A positive EBITDA says nothing about whether a company can pay its bills, because investments, working capital, interest and taxes are missing.
• Inconsistent definition. If other taxes, exceptional write-downs of current assets or income from participations are treated differently from period to period, time series and comparisons lose their meaning.
• Capitalised own work not disclosed. An EBITDA raised by capitalisation stands out in the due diligence and damages the credibility of the other figures.
• Accounting standards mixed. Valuing an HGB EBITDA with multiples from IFRS financial statements leads to distorted values because result and net debt are composed differently.

Frequently asked questions

How is EBITDA calculated?

Most simply backwards: income taxes, interest expense and depreciation and amortisation are added to net income for the year, interest income is deducted. In the worked example, this gives 840 plus 360 plus 220 minus 20 plus 600 = 2,000 thousand euros.

What is a good EBITDA margin?

There is no universal threshold, because the margin depends on the business model. Comparison is made with companies of the same sector and size and with the company's own development. Capital-intensive companies need a higher margin because they must earn the replacement of their assets from it. With depreciation and amortisation of 8% of revenue, an EBITDA margin of 18% leaves only a 10% EBIT margin.

What is the difference between EBITDA and EBIT?

Depreciation and amortisation. EBIT deducts them, EBITDA does not. In the worked example, EBITDA is EUR 2.0 million and EBIT, after EUR 600,000 of depreciation and amortisation, EUR 1.4 million. The more tangible fixed assets a company needs, the larger the gap and the more important EBIT becomes for valuation.

Can EBITDA be positive although the company makes a loss?

Yes. High depreciation and amortisation, interest expense or taxes can turn a positive EBITDA into a net loss for the year, typically in debt-financed companies with high fixed assets. An acquisition after which goodwill is amortised on a scheduled basis, that is, the part of the purchase price above the recognised assets of the acquired company, is also common.

The Roemer Capital view

In funding rounds and sale processes, Roemer Capital fixes the EBITDA definition before the first figure goes to investors or buyers and derives it traceably from the income statement. Capitalised own work, leasing effects and the treatment of other taxes are shown openly so that the due diligence is conducted about the business and not about definitions.

Where Roemer Capital acts as fractional CFO, that is, takes over the finance function for a period, it builds monthly reporting so that an LTM EBITDA can be derived from the monthly financial statements at any time. This shortens the preparation of a company sale, which usually takes 6 to 12 months, and makes every adjustment verifiable period by period.