Depreciation, in particular, can be adjusted by company management to make profits look better.įinally, EBITDA is useful for comparing the earning power of companies of various sizes, with different tax situations and different debt structures. Investors may also use EBITDA to filter out effects of management manipulation of financial results. This may provide a clearer picture of the company’s earning potential. To remove the effects of decisions about how to figure depreciation, investors can look at EBITDA. In addition, EBITDA is useful is that there are not always hard and fast rules about how to calculate depreciation. That knowledge helps you understand how well a company can handle its operating costs. Because it excludes costs for depreciation and amortization, EBITDA also can provide insights into a corporation’s cash flow that operating income does not. Uses for EBITDAĮBITDA is used to understand the earning power of a company’s operations, rather than the actual earnings from operations. A gain or loss on the sale of an asset is an example of a non-operating income or expense item that would be added back to net income to produce EBIT. However, unlike operating income, EBIT includes non-operating income and non-operating expenses. EBIT also adds back interest and tax payments to the net income figure. The operating income figure does not include paying interest and taxes. Depreciation and amortization are non-cash expenses. The expenses subtracted from net sales to figure operating income also include depreciation and amortization.ĬOGS and SG&A are cash expenses, meaning the company had to pay out money for them. In addition to COGS, other operating expenses subtracted from net sales to get operating income include sales, general and administrative (SG&A) expenses. Operating income = Gross income – Operating Expenses The formula for operating income looks like this: COGS includes materials, labor and other expenses directly related to producing the company’s goods and services. Gross income consists of all the company’s income minus the cost of goods sold (COGS). To figure operating income, subtract operating expenses from gross income. Similarly, EBITDA differs from operating income because it adds back some expenses to the net income figure. EBIT is another widely used financial measure that adds expenses for interest and taxes back to net income.ĮBITDA = EBIT + Depreciation + AmortizationĪs the formula shows, what makes EBITDA different from EBIT is that EBITDA adds back amounts for depreciation and amortization. Amortization, another non-cash item, is the amount loan balances are reduced as the company pays off its debts.ĮBITDA = Net Income + Interest + Taxes + Depreciation + AmortizationĪnother way to calculate EBITDA is by taking the figure for earnings before interest and taxes (EBIT) and adding back depreciation and amortization. It accounts for the loss in value over time of assets the company owns. Taxes consist of any income or other taxes that the company paid during the period.ĭepreciation is a non-cash item. Interest includes interest paid on loans. This can also translate into your marketing activities and attract more customers.Starting with net income, one gets to EBIDTA by adding back any expenses for interest, taxes, depreciation and amortization. Lower operating costs will help you stay competitive in the market as you can pass on your savings in this area to your consumers by offering lower prices. Cut back on consultants or professional servicesĬutting costs ensures that you have the money you need to put into growing your business.Add more automation into your production process to reduce labor costs.Reduce transportation costs by having a supplier closer to you.Find a new supplier that has a better price or better delivery time.To give you an idea, here are some ways to keep your operating expenses at a minimum. Reducing your operational cost will depend on the type of business you run. In the event that the company is not able to sell its products or services to cover its operating costs, the company must borrow money to continue operations. Take a look at your finances and see where you can cut back. If you are a small or a startup business, you may have to keep your expenses down to a bare minimum.
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