Charlie Munger called EBITDA BS earnings, and banks and buyers use it anyway. Stephen Brown breaks the acronym down letter by letter with ecommerce examples: interest on the loan you took to stock up for the holidays, depreciation on the warehouse forklift, amortization on a premium domain. QuickBooks Online will not calculate it for you, but it is the number that comes up when you seek funding or sell.
Profitability
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3 min
Transcript
0:00 What EBITDA stands for
Hi, I'm Stephen with LedgerGurus, and in this video I'm gonna talk about a weird financial term, EBITDA, and I'm gonna give specific examples for ecommerce businesses.
EBITDA stands for earnings before interest, taxes, depreciation, and amortization. In essence, EBITDA looks at your business's income before some of the more complex accounting procedures around taxes and depreciation. Think of it as the pure performance of your business operations.
0:22 Each letter explained
Let's dive into each component of EBITDA.
E is earnings, where it's your revenue minus your cost of goods sold, minus your operating expenses.
The B is before. It's before certain other things are taken out or applied.
The I stands for interest. Interest expenses come from loans. A good example is an online seller. As you take a loan out to buy inventory for the holidays, as you pay back that loan, there's interest expenses. That is the I that gets taken out.
T stands for taxes. Income taxes take a bite outta your profits. Since taxes vary, we exclude them to get a consistent view of operational performance.
D stands for depreciation. Depreciation is a more complex accounting exercise where you take the value of an asset, which is on your balance sheet, and you expense it over time. For example, you buy a forklift for the warehouse or computers for the office. They lose value gradually and are expensed over time. That is depreciation.
A stands for amortization. Amortization is another complex accounting concept. For example, if you bought a customer list or a premium domain name, that's very expensive. You can spread out those costs over time, reflecting a longer term value to the business.
Each of these can significantly impact your bottom line or profits, but EBITDA strips them away to reveal the true earnings from your day-to-day operations.
1:33 Why EBITDA is used
Alright, now that you know what EBITDA is, let's talk about why it's used.
Charlie Munger, the legendary investor, may he rest in peace, used to say that EBITDA was BS earnings. The reality is a lot of people like to use EBITDA, banks, financial institutions, buyers. It's gonna come up in those situations and more.
EBITDA provides a clear picture of operating profitability. A lot of those other items may change depending on the owner, depending on how much funding they have, depending on how much loans they use. And so EBITDA strips away all of that noise and gets to the pure operational earnings. Companies may have different tax and financing structures, so EBITDA provides a measure that is comparable across different companies.
2:09 Why it isn't in QuickBooks
But here's the kicker. You won't find EBITDA in a lot of small business software like QuickBooks Online. Why? They're designed for more straightforward financial measurement like net income or net operating income. EBITDA is not part of everyday financials for small business owners, but understanding it is important when you go to get investments, loans, or selling your business.
2:26 How to calculate it
Calculating your EBITDA isn't rocket science. Start with your net income, add back interest, taxes, depreciation, and amortization, and voila, you've got the number that your investors or potential acquirers care about, and a better picture of your operating fundamentals.
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