EBITDA explained: how to calculate it and why it is not cash flow

What is EBITDA?

EBITDA stands for earnings before interest, taxes, depreciation and amortization. It looks at earnings before financing costs, income tax and the depreciation or amortization of tangible and intangible assets. Removing those items from the calculation does not remove the underlying costs or obligations.

Read it alongside the income statement, balance sheet and cash flow statement. Comparisons between businesses or periods require consistent definitions. A measure that excludes additional items needs a distinct label and a clear reconciliation. The SEC's guidance, section 103, explains this distinction between EBITDA and adjusted EBITDA in the context of US issuer disclosures. Those disclosure requirements should not be treated as rules for every company worldwide.

EBITDA formula and worked example

For a simple business with no interest income or complex financing items, the reconciliation is:

Consider a hypothetical company over one year. All figures are in millions in a single reporting currency. Use your own reporting currency when applying the method; no currency conversion is implied. The example has no interest income, other non-operating gains or losses, impairment charges or leases requiring separate treatment. These are illustrative figures, not NG Finance client results.

EBITDA margin is 10.0 / 40.0 × 100% = 25%. It measures EBITDA as a share of revenue. It is neither a markup nor the share of revenue available as cash. When comparing it with the prior year, check changes in product mix, accounting policies, group scope and material expenses.

In this simplified example, operating profit plus depreciation and amortization gives the same result: 8.0 + 2.0 = 10.0. Do not assume that operating profit and EBIT are interchangeable in actual financial statements: other income and expenses can create a difference. Start with a reconciliation rather than a convenient line-item label.

Check the data before using the number

Gather the income statement, a breakdown of interest and income tax expense, depreciation and amortization, and the supporting accounting or management records. For a group, agree the reporting scope and the elimination of intercompany transactions.

• Depreciation and amortization may sit in several expense lines. Review cost of sales, selling expenses and administrative costs. Do not add them back twice or add them to a measure that already excludes them.
• Recognition and payment are different events. EBITDA uses expenses for the reporting period; a cash forecast uses the timing of actual payments.
• Not every tax is an income tax. Do not add back every payment to a tax authority. Check the applicable tax regime and the nature of each expense.
• Match the periods. Do not divide current debt by one unusually strong month's earnings presented as annual EBITDA.
• Lease accounting affects comparability. Different treatments can change reported operating expenses, depreciation and interest. Compare on an agreed basis and retain actual lease payments in the cash forecast.

Where a business operates under a simplified or special tax regime, do not manufacture an income tax add-back from every tax expense. Prepare a transparent management reconciliation and check the methodology required by the relevant lender.

EBITDA versus adjusted EBITDA

Adjusted EBITDA includes further adjustments beyond the basic calculation. A company might, for example, show the effect of a documented one-off event separately. The usefulness of that adjustment depends on its economic substance, likelihood of recurrence and disclosure.

Suppose the example includes 0.6 million of costs associated with closing a specific project. Management proposes adding those costs back to report adjusted EBITDA of 10.6 million. Before relying on that figure, review the evidence, the prospect of similar costs recurring and whether the amount has been paid. Even a well-supported earnings adjustment does not recover cash already spent.

1. Show unadjusted EBITDA and every proposed adjustment separately.
2. Identify the supporting record, rationale, period and cash impact.
3. Challenge recurrence: an annual “one-off” bonus or regular marketing spend does not become exceptional because of its label.
4. Treat comparable gains and losses consistently, rather than adjusting only in the direction that improves earnings.
5. Agree eligible adjustments with the lender when the calculation supports an application or covenant test.

Your adjusted EBITDA is not automatically the lender's EBITDA. Credit documents may define adjustment limits, lease treatment, intercompany transactions and the measurement period differently.

How EBITDA of 10 million can still leave a cash shortfall

EBITDA does not capture every step from recognized earnings to cash in the bank. Customers may not have paid, cash may be tied up in inventory, and equipment purchases and loan principal require separate payments. A cash flow statement addresses actual movements and the reconciliation from earnings, as outlined in the IFRS Foundation's description of IAS 7.

Continue the example. Assume that interest and income tax expense are paid in the same year. There are no other non-cash adjustments, new borrowings, asset disposals, distributions or foreign exchange effects. The increase in working capital represents additional investment in receivables and inventory, net of operating payables; it excludes cash and financing debt.

The result is a cash decrease of 0.9 million despite positive EBITDA. This does not automatically mean a negative bank balance: closing cash also depends on opening cash and any other flows. It does mean that, without an opening cash buffer or another source of liquidity, those payments create a funding need.

This is a management illustration, not a complete statutory cash flow statement. Add every material flow in a real assessment and avoid double counting. For example, purchases may already be captured through movements in inventory and payables. Use a 13-week cash flow forecast to test payment timing as well as the annual total.

Using EBITDA to assess leverage

Net debt to EBITDA is one analytical reference point. Assume interest-bearing debt of 33 million and 5 million of unrestricted cash available for repayment. Net debt is 28 million. Dividing that amount by annual EBITDA of 10 million gives 2.8×.

A ratio of 2.8× is not a repayment period and does not establish that a company meets a lender's requirements. EBITDA is not fully available to repay debt. Define the debt and eligible cash, lease treatment, reporting period and permitted adjustments. With zero or negative EBITDA, the ratio does not provide the usual meaningful measure of leverage.

Review the result alongside the repayment schedule, seasonality and debt service coverage ratio, or DSCR. For an existing covenant, use the contractual definition. For a new application, a lender may apply its own methodology; there is no universal pass mark for every business.

A practical review process for business owners and finance teams

1. Define the decision. Management reporting, period comparisons, a loan application and a covenant test may require different presentations.
2. Set the period and scope. Identify the entities, reporting currency, consolidation policies and source of each figure.
3. Reconcile EBITDA to net income. Every add-back should be supported and traceable to the underlying accounts.
4. Separate the base and adjusted results. Retain the calculation before disputed exclusions.
5. Build the cash bridge. Include taxes, interest, working capital, investment, debt repayments and owner distributions.
6. Run a downside case. Late collections, margin pressure and unplanned repairs can weaken liquidity even while EBITDA remains positive.
7. Match the response to the cause. Collecting receivables, changing purchasing decisions and rescheduling debt address different problems. Additional borrowing does not automatically fix an unprofitable business model.

Frequently asked questions about EBITDA

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