What is EBITDA / EBITDA
Very often in publications of the operating results of companies there is such a financial performance indicator as EBITDA. What is EBITDA and how is it calculated?
The meaning of EBITDA in simple words
EBITDA - that an English abbreviation derived from the English Earnings Before Interest, Taxes, Depreciation and Amortization. EBITDA is an operating measure that shows the profit that a company has earned before taxes, loans, etc. are paid. In simple words, it is all the money earned by the company before all "bills" are paid.
For example, a company produces some product, sells it to a consumer and receives money for it. The amount of revenue depends on the price of the product and the volume sold.
However, in order to sell its products, the company has to spend a certain amount of its resources: these are expenses on wages, electricity, raw materials, advertising, etc. Some part of these expenses may not be included in the reporting period - this is depreciation, i.e. a decrease in the paper value of assets, but in fact the company does not pay anyone for the depreciation of funds. Accordingly, EBITDA will correspond to the volume of revenue, excluding cash costs.
The EBITDA parameter is used as a cash flow assessment tool and allows comparing companies belonging to the same sector but differing in capital structure.
EBITDA is not included in IFRS financial statements, so companies disclose it in presentations when announcing their operating results.
How EBITDA is calculated
There are two main ways to calculate EBITDA.
The first way:
EBITDA = operating profit + depreciation and amortization expenses
For example, for the reporting quarter, the company's operating profit amounted to 130 million dollars. Amortization expenses in the same quarter amounted to $30 million. Calculating EBITDA using the first method, we get:
EBITDA = 130 + 30 = 160 million dollars.
However, based on the formal name, many companies include in its calculation all sources of income and expenses, regardless of whether they are related to the main activities of the company or not. This makes it possible to include in profits income received from secondary operations, investments or one-off sales of some assets. Hence the second way of calculating EBITDA.
The second way:
EBITDA = net income + tax payments + interest on loans + depreciation and amortization expenses
Let's use the example above, adding the net income figure for the quarter under review of $71 million, tax payments of $57 million, and interest on loans of $2 million.
Calculating EBITDA by the second method we get:
EBITDA = 71 + 57 + 2 + 30 = 160 million dollars.
Nuances
In theory, EBITDA should be the same regardless of how it was calculated, but in practice the results can be very different. This is due to the fact that the company has received high profits from investments or the sale of part of its assets.
Unfortunately, some unscrupulous companies may indicate this in their "Income Statements" indirectly, thereby misleading investors. In addition, for example, a company may calculate EBITDA one year in one way and the next year in another way. As a result, the assessment of the company's performance is rather overstated.
If a company consistently uses only one way to calculate EBITDA, then it is a fairly effective way to compare financial performance.
EV/EBITDA and EBITDA margin
EBITDA is an absolute indicator and, as we have already mentioned, is used to compare companies in the same sector. In addition, this indicator is used by analysts in various multiples.
The most common multiple is EV/EBITDA (Enterprise value/EBITDA) - the ratio of the company's value to EBITDA.
The EV/EBITDA multiple indicates how much EBITDA investors value a company's business at. Each sector has its own average EV/EBITDA multiple. Using this sector average and its dynamics, an investor can get a fairly quick estimate of the fair value of the company.
Another effective application of EBITDA is EBITDA margin or EBITDA margin. This multiplier is calculated according to the formula:
EBITDA margin = EBITDA / sales revenue
EBITDA margin multiple shows the efficiency of the company, allows the investor to assess the profitability of the company and the potential for future investments, and gives a deeper understanding of the financial stability of the company than its profitability indicators.
Disadvantages of EBITDA
Despite its widespread use and demand, the use of EBITDA by an investor to assess the profitability of a company has two serious drawbacks:
- it will not provide an adequate and correct assessment of the efficiency of companies that use very expensive equipment or equipment purchased through debt;
- Some companies may have high EBITDA while having low net income and profitability.
As a result, we can conclude that EBITDA and multiples with its participation are quite effective tools for assessing and comparing the net profitability of companies, their fair value and investment potential, but fortrader.org experts remind that when using them one should take into account the existing drawbacks.