EBITDA full form is Earnings before interest, taxes, depreciation and amortization. EBITDA is a simple measure of the company’s financial position. which is used in place of net income.
What is Ebdita
To have deep knowledge of the basics of stock market, it is important that you get the information about EBITDA.
EBITDA is earnings before interest, taxes, amortization and depreciation. This earnings measure measures the company’s profitability before all deductions. Which is considered very useful for investors while taking decisions.
In simple words, it is the net income of a company which includes some of the company’s expenses such as interest, taxes, amortization and depreciation.
Investors use EBITDA as a coverage ratio to compare larger companies before investing in a company. EBITDA provides the applicant with a figure that better reflects the operating profitability of any business, which can effectively be compared between companies by company owners, buyers and investors.
This is why a good investor looks at EBITDA to find out whether a company is more attractive or not. Investors often use EBITDA as a coverage ratio to compare larger companies.
What is EBITDA Margin
EBITDA margin describes the relationship between a company’s total income and total revenue. It is often said by big investors that a company’s high margins indicate how much cash profit that company can generate in a year.
Moreover, it comes in handy while comparing the performance of similar companies operating in a specific industry.
However, EBITDA is not registered in the company’s financial statements. Due to which investors need to calculate it themselves.
EBITDA margin is calculated using the formula given below👇
EBITDA Margin = EBITDA / Total Revenue
Typically, a company with relatively high margins is considered by investors to have significant growth potential.
For example, the EBITDA of an xyz private limited company is Rs 700,000 and the total revenue of the company is Rs 7,000,000.
On the other hand, zxy private limited company has registered Rs 750,000 as EBITDA and Rs 9,000,000 as its total revenue.
So according to the formula,
EBITDA Margin for Xyz Private Limited Company = EBITDA / Total Revenue
= 700000/7000000
= 10%
EBITDA Margin for zxy private limited company = 750000/9000000
= 8%
Therefore, despite having higher EBITDA, the EBITDA margin of zxy Private Limited Company is lower than that of xyz Private Limited Company. It means that xyz private limited company is financially more efficient and hence the potential investor should choose xyz private limited company for investment.
How is Ebdita calculated
To calculate EBITDA, net income is calculated by adding the interest paid by the company, depreciation charged on assets and taxes and the amount of loan repaid.
It is an argument of companies that EBITDA is a better measure of knowing the real income of the company. It can be used to compare companies operating in the same industry or in different industries.
The formula to calculate EBITDA is 👇
EBITDA = Net Income + Interest + Taxes + Depreciation + amortization
The word EBIDTA has five meanings.
E- Earnings
B – Before
I – Interest
T – Taxes
D – Depreciation
A – Amortization
(1) Earnings :- Earnings actually means net profit or net income. Earnings are seen at the bottom of the Income Statement.
(2) Interest :- As you know, when a company takes a loan from any bank or anyone else, it has to pay interest on that loan. This has to do with how that company’s debt is structured. The debt structure can show you whether the company is highly indebted or not.
This can help the investor understand whether his investment will be risky or not. But that still doesn’t help you show how well the company is performing.
(3) Taxes :- The money that a company pays to the government every year as tax. All federal, state, and local taxes are removed when measuring net profit.
Tax expense varies from year to year and from business to business. It also often depends on the company’s industry, location, and size.
This figure is usually found in the operating income expense section of the income statement. Although you also have to pay income tax in the share market, but that is a different issue.
(4) Depreciation :-
The value of any company asset depreciates over time due to use, wear and tear or maintenance. This deficiency of the company is measured as depreciation. Depreciation plays a greater role in some businesses than others.
For example, any company has to set up a manufacturing facility to run it and many types of vehicles and machines are used in manufacturing, so with time they get damaged due to which the company has to spend money on them. That is called Depreciation in simple language.
Moreover, depreciation does not show you at all how well the company performs.
(5) Amortization :- Amortization is a type of accounting technique used to periodically reduce the book value of a loan or intangible asset over a specified period of time.
In relation to debt, amortization is the process by which a company pays off its debt. Amortization When applied to an asset, amortization is similar to depreciation.
Amortization, in any case, does not reflect how well the company is performing.
What are the benefits of EBITDA
- It helps in providing an overview and growth of the business.
- The risk of variables that often affect financial variables, including capital investments,
- Reflects the real value of the company’s cashflow.
- EBITDA takes into account only those expenses of a company that are necessary to run the day-to-day operations of a company.
- Especially it helps in comparing the financial efficiency of a company against its similarly operating companies.
What are the disadvantages of Ebdita
- The company’s debt expenses are always excluded from EBITDA, which results in inaccurate figures. Ebdita never discloses a company’s actual earnings or liquid asset value.
- You will be surprised to know that many business owners also use Ebdita to hide their company’s poor financial decisions and shortcomings.
- It does not affect high-interest financial loans.
- This means that depreciation, amortization and EBITDA cannot be measured as actual expenses while assessing the financial performance of a company.
- Therefore, EBITDA is not a good way to know about a company as a whole but still a lot of investors use it to get information about the company.
History of EBITDA
EBITDA was used by Liberty Media Chairman John Malone in the 1970s to simply learn about the industry. EBITDA is the invention of one of the investors who gave Buffett a run for his money.
Conclusion
Many investors do thorough research about any company before investing in it, due to which ebdita helps investors to understand the income statement and balance sheet of the company.
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