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Financial regulations 16 Aug 2018

What is EBITDA?

EBITDA, or Earnings Before Interests, Tax, Depreciation and Amortization, is an accounting measure that shows the gross income before financial expenses are deducted, and which allows financial analysts to assess the behavior and financial standing of companies.

Although EBITDA is widely used in financial reporting, it is part of the so-called alternative performance measures (APM). According to the Spanish National Securities Market Commission, APMs are financial indicators that are not included in the mandatory financial reporting framework. They are usually calculated based on the financial statements prepared following applicable accounting regulations, normally by adding or deducting amounts from the amounts reported in said financial statements. Although there are other performance measurement alternatives, the Bank of Spain recognizes that EBITDA is one of the most popular among non-financial companies.

Each company’s income and expenses configuration depends on its core business. However, the essential condition that all income and expense amounts included in EBITDA must meet is that they are linked to one of the company’s operating activities. In other words, that they are somehow related to the main source of ordinary income of the company – excluding fixed capital consumption-. Another condition for these items to be taken into account in EBITDA calculations is that they are recurring.

One of the main advantages of EBITDA compared to other type of performance measures is that it eliminates the impact of certain variables reflected in the companies’ accounts. For example, the indicator does not take into account the different taxation, depreciation and amortization systems, as well as the financial leveraging between companies, which makes it easier to compare the results posted by different companies. Another important aspect of EBITDA is that its goal is not to measure the company’s liquidity, but to assess its ability to generate profits taking exclusively into account its productive activity.

EBITDA= Operating Income + Provisions + Depreciations  and Amortizations

According to the Spanish Accounting and Business Administration Association (AECA), the firms that report EBITDA must justify the calculation thereof based on standardized accounting variables, defined in the annual accounts prepared in accordance with the applicable financial reporting regulatory framework. Also, the calculation must be consistent in its use, both in the different documents released by the company every reporting period, and from a temporary point of view during the different economic years.

The CNMV noted in April 2017 that the use of EBITDA and other alternative company performance measures has increased, especially in recent years. Regardless, accounting regulations, the Spanish General Chart of Accounts (PGC), or the International Financial Reporting Standards (IFRS) are yet to establish a harmonized definition of EBITDA. And that is why supervisors such as the CNMV itself or the European Securities and Markets Authority (ESMA) underscore the need to accompany this type of accounts with sufficient information to guarantee a minimum transparency standard.

In this regard, AECA has also warned about the fact that measures such as EBITDA can render an inaccurate view about a company’s mid/long-term solvency, because their calculation is not always consistent and can be misconstrued. To avoid this, the association has repeatedly set forth the need to establish a single definition of EBITDA, based on a calculation of the effective operating flows and resources. Also, it recommends businesses using EBITDA for financial reporting purposes, to offer sufficient information so as to guarantee transparency in the company’s accounts.

In order to contribute to the standardization and transparency of alternative performance measures such as EBITDA, on October 2015 ESMA published a set of guidelines aimed at companies using indicators such as EBITDA to calculate their results. These European standards – which came into force on July 3, 2016, – are fundamentally linked to the alternative performance measures and calculations adopted by the company.  The main requirements established by the European authority for companies are: The correct presentation of alternative indicators such as EBITDA; an explanation that justifies the use of the measure, the reconciliations with the financial statements of the corresponding period; the comparatives with previous periods and the consistency of the measure over time.

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