The Profit Figure Buyers and Lenders Reach For First
If you have ever read a business sale listing, an investor pitch or a bank's lending paperwork, you will have met EBITDA. It is the profit figure the finance world reaches for before almost any other, and for a small business owner it can feel like jargon dressed up to keep you out. It is not. Once you see what it actually measures, EBITDA is one of the more useful numbers you can put next to your accounts.
This guide explains what EBITDA stands for, gives you the formula, walks through a worked example from a real profit and loss account, and shows you how to read EBITDA margin and adjusted EBITDA. It also draws the line clearly between EBITDA and operating profit, and it is honest about where the figure helps and where it flatters a business that does not deserve it.
What Does EBITDA Stand For?
EBITDA stands for Earnings Before Interest, Taxes, Depreciation and Amortisation. Say it as five separate ideas and the whole thing makes sense.
- Earnings is your profit.
- Before Interest means you add back the cost of how the business is financed, the interest on loans and overdrafts.
- Before Taxes means you add back the tax charge.
- Before Depreciation means you add back depreciation, the accounting charge that spreads the cost of fixed assets over their useful life.
- Before Amortisation means you add back amortisation, which is the same idea as depreciation but applied to intangible assets like software or goodwill.
So EBITDA is your profit with four things stripped out: financing, tax, and the two non-cash charges that write down the value of your long-term assets. The point of taking those out is to get as close as possible to the cash the trading operation itself throws off, before the way the business is owned, financed and taxed gets involved.
The EBITDA Formula
There are two ways to build EBITDA, and both should land on the same number. Use whichever matches the figures you have to hand.
The first works from the top of the profit and loss account downwards:
EBITDA = operating profit + depreciation + amortisation
Operating profit is what is left after cost of sales and overheads but before interest and tax. Because operating profit already excludes interest and tax, you only need to add back the two non-cash charges to reach EBITDA.
The second works from the bottom of the profit and loss account upwards, which is handy when all you have is the headline net profit:
EBITDA = net profit + interest + taxes + depreciation + amortisation
This is the version the acronym describes literally. You start with the final profit figure and add back, one by one, the four things the letters tell you to ignore. Both routes are correct. The top-down version is usually quicker because operating profit has already done half the work for you.
A Worked Example
Take a small engineering firm with a full year behind it. Its profit and loss account looks like this.
- Revenue: £600,000
- Cost of sales: £330,000
- Gross profit: £270,000
- Overheads, including £40,000 of depreciation on machinery: £210,000
- Operating profit: £60,000
- Interest on a business loan: £12,000
- Profit before tax: £48,000
- Corporation tax: £12,000
- Net profit: £36,000
Now build EBITDA the quick way, from operating profit. The firm has machinery, so it carries depreciation, but say it has no intangible assets and therefore no amortisation.
EBITDA = operating profit £60,000 + depreciation £40,000 + amortisation £0 = £100,000
Check it the long way, from net profit upwards, and you should get the same answer:
EBITDA = net profit £36,000 + interest £12,000 + tax £12,000 + depreciation £40,000 + amortisation £0 = £100,000
Look at the gap. Net profit is £36,000. EBITDA is £100,000. The figure has nearly tripled, and not because the business suddenly earns more. The £64,000 difference is simply the interest, tax and depreciation added back. This is exactly why EBITDA is both useful and dangerous in the same breath. Useful, because it shows the trading operation generated roughly £100,000 before financing and asset costs. Dangerous, because £100,000 is not money the owner can spend. The loan interest is real, the tax bill is real, and that machinery will eventually need replacing.
EBITDA Margin: Turning the Figure Into a Ratio
On its own, an EBITDA of £100,000 tells you little until you know the revenue it came from. EBITDA margin fixes that by expressing EBITDA as a percentage of revenue, so you can compare a business against its own history and against others of any size.
EBITDA margin = (EBITDA / revenue) × 100
For the engineering firm above, that is (£100,000 / £600,000) × 100, which is about 16.7 percent. In other words, the trading operation produced roughly 17p of EBITDA for every pound of sales.
As with every margin, there is no single good number. EBITDA margin varies enormously by sector. A software business with very little to depreciate can run an EBITDA margin north of 30 percent, while a haulage or manufacturing firm carrying heavy machinery will look stronger on EBITDA than on net profit precisely because so much depreciation gets added back. That is the trap. A high EBITDA margin in an asset-heavy business can hide the fact that real money is being consumed every year just keeping the equipment running. We cover the wider family of profitability ratios in our guides to gross margin and net profit margin, and EBITDA margin sits above both of them on the same profit and loss account.
Adjusted EBITDA: Useful and Easy to Abuse
When a business is being sold or raising money, you will often see adjusted EBITDA rather than plain EBITDA. The idea is reasonable. A buyer wants to see what the business would earn under normal, ongoing ownership, so genuine one-off or non-recurring items are stripped out to reveal the underlying run rate.
Honest adjustments include things like a one-off legal settlement, the cost of a fire that will not happen again, or an owner's salary that is well above or below the market rate and would change hands on sale. Strip those out and you get a cleaner picture of repeatable trading profit. This is the normalisation that any sensible business valuation depends on, and we go into it further in our guide to how to value a business, where EBITDA is usually multiplied to reach a headline price.
The catch is that adjusted EBITDA has no fixed definition. Nothing stops a seller adding back costs that are not really one-off at all, so the figure quietly inflates. The defence is simple. Read every adjustment and ask one question of each: would this cost genuinely disappear or change under a new owner running the business normally? If the honest answer is no, the add-back does not belong. Treat a long list of vague adjustments as a warning, not a feature.
EBITDA vs Operating Profit
People often use EBITDA and operating profit loosely, but they are not the same, and the difference is exactly the depreciation and amortisation.
Operating profit is profit after cost of sales and overheads but before interest and tax, and it still has depreciation and amortisation deducted. EBITDA is operating profit with those two non-cash charges added back. So EBITDA is always equal to or higher than operating profit, and the gap between them is the size of your depreciation and amortisation charge.
| Measure | Includes depreciation and amortisation? | Includes interest and tax? | What it shows |
|---|---|---|---|
| EBITDA | No (added back) | No | Cash-like trading profit before asset and financing costs |
| Operating profit | Yes (deducted) | No | Profit from core operations after asset costs |
| Net profit | Yes (deducted) | Yes | What the business actually keeps |
The practical point is that the wider the gap between EBITDA and operating profit, the more asset-heavy the business is. For a consultancy the two figures sit close together, because there is almost nothing to depreciate. For a logistics firm the gap is large, and operating profit is the more honest measure of whether the business is really earning its keep once the cost of its trucks is counted.
Our View: A Useful Lens, Not the Whole Picture
In our experience, EBITDA earns its keep as a comparison tool. Because it removes financing, tax and accounting policy on asset write-downs, it lets you compare two businesses, or one business across years, on the strength of their trading alone. That is genuinely valuable when you are benchmarking, lending or pricing a deal.
What it must never become is the figure an owner runs the business by. EBITDA deliberately ignores three things that do not go away: the interest on your debt, the tax you owe, and the cash you will need to replace worn-out assets. A business can post a healthy EBITDA and still be unable to pay its bills, which is why the old line that EBITDA stands for "earnings before I tricked the dumb auditor" has stuck around in finance circles. Our advice is to treat EBITDA as one lens among several. Read it next to operating profit to see how asset-heavy you are, next to net income to see what actually survives, and next to your cash flow statement to see whether the profit is turning into money in the bank. No single figure runs a business well, and EBITDA least of all on its own.
How IAK Can Help
We make EBITDA a figure you can stand behind. Accurate bookkeeping ensures depreciation, interest and tax are recorded correctly, so the add-backs that build your EBITDA are based on real numbers rather than guesswork. Our management reporting tracks EBITDA, operating profit and net profit side by side each month, so you see the full picture rather than the most flattering slice of it. And when you are preparing to sell, raise finance or be valued, our accounting and tax planning work produces the clean, normalised figures that buyers, investors and HMRC will actually credit.
If you need to present your EBITDA to a lender or buyer and want it to hold up to scrutiny, that is exactly the work we do. Contact us and we will help you build a number you can defend.
Sources
- FRS 102, the financial reporting standard for most UK small and medium companies, which governs how depreciation, amortisation and operating profit are presented in the accounts that EBITDA is built from. Published by the Financial Reporting Council.
- HMRC guidance on Corporation Tax rates and reliefs, relevant to the tax charge that EBITDA adds back.
- HMRC guidance on capital allowances, the tax counterpart to the depreciation that EBITDA excludes, useful when reconciling accounting profit to the tax position.