EBITDA & Income Statements – Part 4

What is EBTIDA?  First, EBITDA is an acronym for Earnings Before Interest Taxation, Depreciation, & Amortization.  If you are wondering what is EBITDA, this is a non-GAAP standard measure that shows what a company earned from revenues, less cost of goods and operating costs.  It is a useful metric for a new company that is still in the process of scaling up revenue to achieve overall profitability.  EBITDA as a metric shows where the core business is on a profitability basis just before the cost of capital and financing costs in the financial statements.

For companies that are scaling up their operations, achieving EBTIDA profitability is a key milestone after sales have begun.  From a EBITDA basis, should a firm achieve EBITDA profitability, the core costs of producing the product or service have been achieved.  From this point, a firm would need to continue to scale up sales and revenues to cover the costs of financing the firm’s operations.

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How To Use EBTIDA Profitability Metric

If a firm is EBITDA profitable then they can pay for the core costs of producing their products.  But, this does not afford for the financing costs of the operations.  However, after continued scaling up of operations, a firm should achieve net earnings profitability.

But, with EBITDA profitability, this shows that a firm’s plan could be profitable and that after continual scaling up, with marginal revenues & marginal profits, outsized profits will increase at a higher percentage basis.

How to Analyze EBITDA

How to Invest in Stocks Margin Ratios - AAPL Financials

In the above example, you see from Nasdaq website Apple financial data annual.[1]Nasdaq website AAPL stock financial data

If you are wondering how to break down EBITDA, this is done by looking at the first sections of the financial statements.

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Gross Profits

The first segment of a financial statement will have three main sections:

This is typically the first three listings in a generalized breakdown of the financial statements.  A firm will have revenues for the quarter or the year, and the costs of those goods sold.  From these, the difference of revenues less the cost of goods are gross profits for the firm for the quarter, year, or Trailing Twelve Months (TTM).

Gross Margins

The very first goal of a firm that is producing and selling product is to achieve gross profitability.  Positive gross profits are essential and an analyst can compare gross profits of one firm to another by dividing gross profits by revenue to determine gross margins.  The result of this division is a percentage.  And, the higher the percentage the higher the gross margins for the firm.  This metric can be used to compare to other firms.

Operating Profits

The next section of the financial statement are operating profits.  Operating profits take into account Sales, General, & Administrative (SG&A) as well as Depreciation & Amortization.  Also, you may find Research & Development in the operating section of the financial statements.

Operating profits are what are remaining after total operating costs, factoring depreciation and amortization, and any research & development are deducted from what is remaining from gross profits.  This is why achieving a high gross margin are important because a firm will be able to achieve a higher amount of EBITDA profitability.

It is at this point that an analyst can find remove Depreciation & Amortization to show the “core” of the business; the costs related to actually producing & selling a product or service.  EBITDA profitability, relative to revenue can be determined at this point by dividing EBTIDA profitability by total revenue showing a ratio, or percentage.

Operating Efficiencies

Another metric that can be determined at this point is the Operating Efficiencies.  Operating Efficiencies are determined by total operating costs divided by total revenues.  The ratio, or percentage shows how efficiently the “back office” is relative to revenue.  This is called Operating Efficiencies.

EBITDA profitability

An example of a company with actual numbers could be found in the Most Profitable Cannabis Stocks listed in the website.  The Most Profitable Cannabis Stocks takes into consideration both EBITDA profitability levels as well as Net Earnings profitability.

There are different levels of profitability.  A firm will either be EBITDA unprofitable or profitable.  Then, a firm will either be Net Earnings unprofitable or profitable.

It should be noted that a company is usually, but not always, EBITDA profitable before they can be Net Earnings profitable.  The reason boils down to the core business operations.  And, whenever a firm is Net Earnings profitable without having achieved EBITDA profitability, it is typically owed to something outside of the core business.  This portion is found in the Continuing Costs segment of the financial statements and is usually found in the Unusual Earnings/Expenses.

EBTIDA Examples

When analyzing a stock, if you were to compare EBITDA profitability of one firm to another you can get an additional sense of how effective a firm is at what they do.  For instance, when comparing the gross margins of multiple firms, this shows how much profit is retained by a firm from the standpoint of producing the profits.  And, measuring gross margins, and which are the best gross margins of cannabis stocks, of any one firm to another is useful in determining the potential profitability any one firm may have.

Next, determining operating costs relative to all firms allows an analyst to see how efficient any one management is versus another firm.  Some firms have much higher operating costs  than other firms relative to revenue.

Comparing EBTIDA from one firm to another

EBITDA profitability, on a percentage basis, can be used to compare firms to each other.  While one firm may be very good at producing products on a low-cost basis, perhaps they have very high operating costs relative to revenue.  EBITDA would take into consideration both the gross margins and operating efficiencies and could be used to balance out both and then used to compare firms to each other.


1 Nasdaq website AAPL stock financial data

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