EBITDA is one of the extremely familiar indicators widely used in the financial sector. Experts and investors often use EBITDA results to evaluate the success of certain businesses. Based on this result, investors can choose an appropriate investment address.
So What is EBITDA?? Let's find out through the content of this article.
What is EBITDA?
EBITDA stands for Earning Before Interest, Taxes, Depreciation and Amortization, which means profit before tax, depreciation and interest. This is the term used to describe the pre-tax profit of a certain business or organization. This profit still includes taxes, loans and has not deducted depreciation.
We are still familiar with the formula for calculating net profit:
Net Earning = Total revenue – investment costs – interest – taxes
However, not all businesses have the same debt structure and loan capital. Therefore, the tax and property part is also different. From an investor's point of view, EBITDA is an important basis for assessing the future development potential of a business.
Reference: What is Profit Margin?
To calculate the pre-tax profit of a certain business, you can use one of the following three formulas:
- EBITDA = Total revenue after tax + tax + interest + depreciation expense
- EBITDA = Total revenue before tax + interest + depreciation expense
- EBITDA = EBIT + depreciation expense
- The figures for profit before tax, profit after tax, tax, depreciation, interest you can see in the financial statement or cash flow statement of the business.
- Ebit is taken from the business activity table.
For example: your revenue in the past year has a total pre-tax revenue of 10 billion, loan interest 3 billion dong, depreciation expense 1 billion dong. I guess
Ebitda = Profit after tax + Tax + Interest + Depreciation = 10 + 3 +1 = 14 billion VND.
Find out what is the quick ratio?
Meaning of EBITDA
Besides the indicators of profit before tax, profit after tax, profitability ratio ... EBITDA has important meanings for businesses and investors.
With the elimination of 2 costs are:
- Interest expenses related to debt (i.e., capital structure), and…
- Tax-related tax expenses (does the business get tax incentives?)
EBIT helps focus on your ability to generate income from your core business.
EBIT helps you consider:
- How can businesses control costs?
- How does the core business of the business make a profit without having to worry about taxes and interest?
- Does the business generate enough income to be profitable, repay debt, and finance other ongoing activities?
From there, business owners and investors can:
- Evaluating the business performance of the business is more accurate, thereby making a correct judgment about the potential for future development.
- Eliminating accounting factors creates the most perfect financial picture for companies and businesses.
- Help beautify financial statements, create confidence for investors
Learn What is an IPO?
EBITDA's Role in Business Analytics
EBITDA has eliminated fees that affect business performance. Three factors including interest, taxes and amortization were eliminated by EBITDA.
The reason loan interest has been excluded is because the financial structure of each business is not completely the same. As a result, interest expenses on loans also fluctuate accordingly. The more debt you borrow, the higher the interest rate will be. In addition, deductions from taxes can also be considered as interest. They are tools many businesses use as tax shields.
Corporate income tax is also excluded from EBITDA. Because this factor easily affects loan interest and many other expenses. This makes the actual net profit result inaccurate.
Depreciation and Amortization
Depreciation factor is subjective, so it will also be excluded from EBITDA. By excluding many unnecessary factors, it makes comparing profits between businesses or industries more accurate and easier.
When Should EBITDA Calculation Be Used?
People will use EBITDA for business units with large total assets. For the purpose of minimizing the calculation stages of depreciation of fixed assets.
In case you want a more objective assessment of the industry average, you can also rely on the EBITDA results. In addition, in the field of EV/EBITDA valuation, people also use the EBITDA calculation method. In some other fields, EBITDA is also applied quite a lot.
Usually, the Ebitda index is used in the following cases:
- Ebitda is commonly used in Manufacturing industries with high asset value, proportion and scale make depreciation expense high. The use of Ebitda in this case helps to beautify financial statements for businesses, creating confidence for investors.
- When need to compare the Ebitda index over a longer period of time than the averages of companies in the same industry. This helps investors get an overview and more accurate about the business they are interested in.
- Ebitda index is apply for calculation in EV/Ebitda valuation model or valuation cash flow models. In some cases, investors also use Ebitda to replace cash flows during business operations.
- Ebitda is used to comparison in a number of valuation models such as: Ebitda Margin, Ebitda/interest expense, Ebitda/depreciation expense, Debt/Ebitda...
Reference: What is NPV?
Some Myths That EBITDA Caused Investors
The fact that EBITDA has excluded many important criteria causes many misunderstandings with investors. Specifically, many people will think of EBITDA as a proxy for cash flow. However, EBITDA only indicates profitability, not cash flow. Because it has no impact on working capital flow.
In addition, EBITDA also makes it easy for investors to misjudge the performance of the business. Since taxes, interest and depreciation have been removed, the value of EBITDA is often much larger than the net profit.
Here are some notes about the Ebitda index that businesses should know:
- The Ebitda Index is not a substitute for cash flow
- Ebitda index can skew interest expense
- The quality of net profit should not be overlooked
- Ebitda index makes the company cheaper
Let's find out the details together.
The Ebitda Index is not a substitute for cash flow
The Ebitda Index excludes interest expenses and corporate income taxes. However, in reality, no business can operate without using interest expenses and paying taxes to the state. Therefore, it is very absurd to consider only the Ebitda index without regard to the cash flow of the business.
Ebitda index can skew interest expense
To make this clearer, we give a specific example as follows: A business generates a profit after tax of VND 100 million, interest expense to be paid is VND 110 million, depreciation expense is VND 100 million. 50 million dong. Thus, if we consider only these 3 factors, we can see that the company's Ebitda is VND 260 million and the company has enough money to pay interest expenses.
However, in reality, the company's machinery and equipment during use will wear out and need to be repaired and upgraded. Therefore, the business is not doing really effectively, it is difficult to pay interest expenses.
The quality of net profit should not be overlooked
During the calculation process, the Ebitda index may be affected by accounting tricks with the aim of creating high Ebitda figures, creating confidence for investors. That's why the Ebitda index is not really reliable, you should not rely solely on this index but ignore the quality of the business's net profit.
Ebitda index makes the company cheaper
Another drawback of the Ebitda index is that it can make your business cheaper than it really is. This happens when investors are only interested in multiples of the Ebitda index and ignore the data on the net income of the business.
Find out what is net revenue?
Compare Ebitda And Ebit
There are many people who often mistakenly think that Ebitda and Ebit are an indicator, but in fact these are two completely different concepts. We can compare these two indicators through the table below:
|Ebit is profit before interest and taxes||Ebitda is profit before interest, taxes and amortization|
|Ebit includes revenue minus expenses, excluding interest expenses and corporate income tax. Therefore, it is a measure of company profitability.||Ebitda includes revenue minus expenses, excluding depreciation, interest and personal income taxes. Therefore, it is a measure of the company's performance.|
|Formula to calculate Ebit:|
Ebit = profit before tax + interest expense
|Formula to calculate Ebitda:|
Ebitda = Profit after tax + Tax + Interest + Depreciation
= Profit before tax + Interest + Depreciation
= Ebit + Depreciation
Indicators Related to EBITDA
The EBITDA margin is used when comparing a company's performance from year to year or comparing its performance with peers in the same industry. The formula for calculating this index is as follows:
Net Debt Ratio / EBITDA (Net Debt/EBITDA)
This metric shows how long it will take for a business to pay off its debt at current EBITDA levels. The formula for calculating this index is as follows:
|EBITDA margin||=||Net debt|
|Net debt||=||Short-term debt||+||Long-term liabilities||–||Money and Accounts cash equivalents|
After all the sharing of Banktop, I hope you know What is EBITDA?. It also helps you to know when to use EBITDA and when not to include EBITDA results in business reviews.
Information edited by: banktop.vn