EBITDA is a popular term among businesses and investors these days. But many people do not understand what it is and what its importance is. I recently came across a nice chart in which Nicolas Boucher has given a simple and clear explanation of EBITDA. Let’s understand how EBITDA works and why it is useful for you.
What is EBITDA?
EBITDA is an abbreviation for ‘Earnings Before Interest, Taxes, Depreciation, and Amortization’. This means that it is a figure that shows how much money a company earns from its business, excluding interest, taxes, depreciation, and amortization. It is actually a measure of how much profit the company makes from its core business.
For example, if a company’s revenue is Rs 10 lakh and its expenses are Rs 6 lakh, then EBITDA will be Rs 4 lakh. But these figures are separate from interest or taxes.
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Why is it important for business?
EBITDA is like a mirror of the business. It tells you how much money the company is actually making, and not just on debt or taxes. It’s useful for investors because it tells them how strong the company is.
- For investors: It tells them how well the company can pay off its debt and how much profit it has.
- For businesses: It shows how well the company’s core business is doing.
How is EBITDA calculated?
The calculation is simple. You start with the company’s revenue and subtract the cost of goods sold. Then, subtract operating expenses like employee salaries and rent. Finally, don’t subtract interest, taxes, depreciation, and amortization – they’re not included in EBITDA.
- Formula: EBITDA = Net Income + Interest Expense + Taxes + Depreciation + Amortization
- Example: If Net Income is 2 lakhs, Interest is 50,000, Tax is 30,000, Depreciation is 20,000 and Amortization is 10,000, then EBITDA = 2 lakhs + 50,000 + 30,000 + 20,000 + 10,000 = 3.1 lakhs.
What is EBITDA Margin?
EBITDA margin is an important ratio that shows how much of a company’s revenue is converted into profit, excluding interest, taxes, depreciation and amortization. It is useful in assessing the financial health of a company.
Example: If a company’s total revenue is Rs 10 lakh and its EBITDA is Rs 3 lakh, then EBITDA margin = (EBITDA / Revenue) x 100 = (3 lakh / 10 lakh) x 100 = 30%. This shows that up to 30% of the company’s revenue is profit, which comes from its core business.
Difference between EBITDA and Net Income
There is a big difference between Net Income and EBITDA. Net Income includes all expenses (interest, tax, depreciation), which actually show the profit accruing to the account. But EBITDA excludes these non-cash expenses (Depreciation, Amortization), so that the focus is on the core performance of the company.
E.g.: If Net Income is 1 lakh and Depreciation is 40,000, then EBITDA will be 1.4 lakhs.
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How is it used in practice?
Businesses and investors use EBITDA to assess the health of a company. It is especially useful when making comparisons – e.g. if you want to see the profits of two companies, you can see whose performance is better by looking at their EBITDA.
Example: If Company A has an EBITDA of 5 lakhs and Company B has an EBITDA of 3 lakhs, then A can be said to be performing better than B, all other things being equal.
Know something more about EBITDA
- EBITDA is just one number, it is not the whole picture. You need to look at debt, taxes or future investments.
- It may be less useful for small businesses, as their expenses are different.
- Investors should also check other metrics like P/E Ratio or Cash Flow along with EBITDA.
My own view
After looking at this chart, I think EBITDA is indeed a good tool for investors. But I personally would not rely on EBITDA alone when buying shares – I would also look at the company’s debt, earnings stability and market position. You too should think from all sides when trading or investing, and do not trust just one number!
If you have any further doubts, be sure to ask me. I will explain it to you in simple terms!
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FAQ:
1. What does EBITDA stand for?
EBITDA stands for Earnings Before Interest, Taxes, Depreciation, and Amortization, showing a company’s core profit from operations.
2. How is EBITDA calculated?
Start with revenue, subtract cost of goods sold and operating expenses (like salaries), then add back interest, taxes, depreciation, and amortization.
3. Why is EBITDA important for investors?
EBITDA helps investors assess a company’s profitability and operational efficiency, ignoring non-cash expenses like depreciation, aiding in fair comparisons.
4. What’s the difference between EBITDA and Net Income?
Net Income includes all expenses (interest, taxes, depreciation), while EBITDA excludes them to focus on operational earnings.
5. Can EBITDA be misleading for investments?
Yes, it’s not the full picture—check debt, cash flow, and P/E ratio alongside EBITDA to make informed investment decisions.