EBITDA stands for Earnings before Income, Tax, Depreciation, and Amortization. This is an important metric that tells you a company’s operating performance such as whether a company has an ability to generate cash flow or not. Many stock analysts use EBITDA to know a company's net earnings so as to know the share trading value of the same.
Introduction to EBITDA
EBITDA is basically a financial metric that tells a company about its financial performance before tax, depreciation etc. EBITDA can also be used as a net income. In other words, EBITDA is a useful tool that helps company professionals to evaluate a business.
Business experts use EBITDA to compare two small businesses. Here are the important factors which need to be considered:
Earnings - Income get from an investment
Interest - Money paid toward a loan or debt incurred by deferring loan repayment
Tax - The government applied tax on the organization
Depreciation - The decrease in the life of the asset
Amortization - The process of reducing or paying off debt at regular intervals.
Asset - An asset which has some value and that can be tangible and intangible such as real estate and intellectual property.
EBITDA as a Financial Metric
Many experts considered EBITDA as a financial metric as it tells a firm’s operating profit without taking into account things like equipment, property and investment amount.
However, it is often used to cover the poor financial judgment. With all these aspects, it is still considered as an important financial metric.
EBITDA Vs EBIT
EBITDA and EBIT are very much similar to each other. The only difference is that EBITDA includes Interest, Tax, Depreciation and Amortization whereas EBIT includes only Interest and tax. EBITDA is mainly used to compare different companies while EBIT is used to evaluate the profitability of a single company.
EBIT gives you complete information regarding a company’s operational health without the loss of money for Interest and Tax, however, it excludes a portion of money which is spent on Amortization and Depreciation.
How to Calculate EBITDA?
The formula for calculating EBITDA is given below:
EBITDA = Net Income + Interest Expense + Taxes + Depreciation + Amortization
Steps to Measure EBITDA
1) Acquire the Business Income Statement
An income statement simply means a document which depicts a business’s overall revenue and costs in different periods such as a fiscal quarter or a year. Income statements can be categorized into 2 categories: such as revenue and expenses. These categories can be subdivided into different categories such as specific earnings or costs.
2) Find out Figures
All the figures that can be used to calculate the EBITDA are present in the income statement. Now, you need to find interest expenses and taxes. This will be counted as a non-operating subcategory of the expense category. After that, you are required to write depreciation and amortization numbers.
3) Calculate EBITDA
The calculation of EBITDA can be done as:
Net Income + Tax + Interest Expense + Depreciation and Amortization
What is EBITDA Margin?
EBITDA margin shows the cash profit a firm can generate in a year. The calculation of margin can be more useful if analysts compare a firm’s performance to its competitors.
The formula of EBITDA is:
EBITDA Margin = EBITDA/ Aggregate Revenue
The EBITDA of XYZ is Rs 7,00,000 while the aggregate revenue for the same is Rs 70,00,000. A second company called DEF’s EBITDA is registered as Rs 8,00,000, while its aggregate revenue is 85,00,000.
According to the formula discussed above:
EBITDA Margin of Company XYZ Ltd is 7,00,000/70,00000 = 10%
EBITDA Margin of company DEF Ltd is 800000/8500000 = 9.41%
When One Can Use EBITDA?
EBITDA can be used in the following business activities:
Budgeting
If you want to add the cost of extra machinery in your next year’s budget plan, EBITDA will come into play as it will tell you the overall company’s financial health along with the right timings regarding the addition of extra expense.
Downsizing
If you want to downsize your staff but get confused about your decisions, EBITDA analysis will help you make decisions objectively, not subjectively.
Investing
Let's say you've had your eye on a firm and are considering investing. The EBITDA may help you determine whether the firm has high growth potential, especially when compared to comparable companies, and whether or not joining the team is beneficial.
Forming an Exit Strategy
If you're ready to retire from your firm and want to sell it, and EBITDA analysis can show buyers that it's a good investment and help you choose the right asking price.
Conclusion
EBITDA is used to measure a company’s overall financial performance. Analysts use it as an alternative to the net income in some circumstances.
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