EBITDA, or earnings before interest, taxes, depreciation, and amortization, is a financial performance indicator that is used as the pre-tax, pre-interest measure to represent the flow of both equity and debt. EBITDA can be used to analyse and compare profitability among companies and industries, as it eliminates the effects of financing and capital expenditures.
Interest expenses and (to a lesser extent) interest income are added back to net income, which neutralizes the cost of debt and the effect interest payments have on taxes. Income taxes are also added back to net income, which does not always increase EBITDA if the company has a net loss.
EBITDA, on the other hand, is deceptive because it excludes the cost of capital investments like property, plant, and equipment. This metric also excludes expenses associated with debt by adding back interest expense and taxes to earnings. Nonetheless, it is a more precise measure of corporate performance since it is able to show earnings before the influence of accounting and financial deductions.
Nonetheless, because it can reflect earnings before accounting and financial deductions, it is a more precise indicator of business performance. Simply put, EBITDA is a measure of profitability.
Methods To Calculate EBITDA: –
There are two methods to calculate EBITDA, one that uses operating income and the other net income.
EBITDA (Using Net Income) = Net Income + Taxes + Interest Expense + Depreciation & Amortization
EBITDA (Using Operating Income) = Operating Income + Depreciation & Amortization
Examples of EBITDA
A retail company generates Rs.1000 million in revenue and incurs Rs.400 million in production cost and Rs.200 million in operating expenses. Depreciation and amortization expenses total Rs.100 million, yielding an operating profit of Rs.300 million. Interest expense is Rs.50 million, which equals earnings before taxes of Rs.250 million. With a 20% tax rate, net income equals Rs.200 million after Rs.50 million in taxes are subtracted from pre-tax income. If depreciation, amortization, interest, and taxes are added back to net income, EBITDA equals Rs.400 million.
Many investors use EBITDA to make comparisons between companies with different capital structures or tax jurisdictions. Assuming that two companies are both profitable on an EBITDA basis, a comparison like this could help investors identify a company that is growing more quickly from a product sales perspective.
What Is An Ideal EBDITA?
Because EBITDA is a measure of a company’s financial performance and profitability, higher EBITDA is plainly preferable than lower EBITDA. The financial performance of companies of various sizes in various sectors and industries varies greatly. As a result, comparing a company’s EBITDA to that of its peers—companies of similar size in the same industry and sector—is the best approach to establish whether it is “good.”