What is EBITDA? Definition of EBITDA:
Definition: EBITDA stands for earnings, before interest, taxes, depreciation, and amortization. It is the financial ratio which measures the profitability of the company before deduction that considered irrelevant in the decision-making process.
In simple words, we can say that it is the income of the company with expenses like depreciation, amortization, taxes, and interest add back in the total.
The analyst uses this ratio as a coverage ratio to compare those companies which have a significant amount of debt and large investment in the fixed debt.
Because EBITDA excludes the nonoperating expenses like interest and depreciation. By adding these nonoperating expenses to the net income analyst can analyze the true operating cash flow of the company.
EBITDA Formula calculated by subtracting all the expense from the net income except interest, taxes, depreciation, and amortization.
EBITDA = Net income + ( Interest expenses + Taxes + Depreciation + Amortization )
This equation often inversely used that ITDA adds back in the net income. Many companies use this for the calculation of different aspect. It is non-GAAP calculation so you can add only those expenses back which you want.
Analysis and Interpretation
EBITDA is used to measure the profitability of the company or firm that before the paying of taxes, interest, and depreciation how the company is profitable. The result of this calculation is in dollars because of which we can say that this is not a financial ratio.
If the result in the high number of any company because of EBITDA calculation that the company generate more profit as compare to lower number result companies. e.g if before ITDA the earning of one company is greater then other then the company with greater earning is the better company.
The analyst thinks that this calculation is not favourable for creditor and customer and investors. Because this calculation does not show the actual value because all the cost which are used for making the profit is not included in this.
For the growing company, extra equipment needs for financing which additional loan require. EBITDA look only for profit but not look at the cost for the business expansion.
It takes the basic formula and converts it into the ratio form. which is the financial ratio. It is used to compare different companies in the same industry.
EBITDA margin calculation can get by dividing the earnings before interest, taxes, depreciation, and amortization equation by total revenue of the company. By this formula, we can compare the big companies with small companies.
EBITDA margin = EBITDA/ Total revenue
Now take an example to understand EBITDA clearly.
Now we take an example of the Ski house for which we calculate EBITDA and EBITDA margin. custom Ski manufacture for both pro and amateur skiers. Total revenue after 1 year is $100,000 and expenses listed below
- salaries= 25,000 dollars
- Rent = 10,000 dollars
- Utilities = 4,000 dollars
- Cost of goods sold = 35,000 dollars
- interest = 5,000 dollars
- Depreciation = 15,000 dollars
- Taxes = 3000 dollars
Taxes, depreciation, and interest added back in net income to find the total earning at the end of the year from which tex and interest can be cover.
Net income at the end of the year is 3,000 dollars. so we can calculate EBITDA as
EBITDA = 100,000 – (25,000 + 10,000 + 4,000 + 35,000)
EBITDA = 100,000 – 74,000
To compare this value with other company we need EBITDA margin which can be calculated as
After the payment of taxes and interest, it generates 26 cents for every dollar. So from this, it can be compared with other companies efficiency and profitability.
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