EBITDA is one of the most familiar metrics widely used in the financial sector. Experts and investors often use EBITDA results to evaluate the success of a certain business. Based on this result, investors can choose suitable investment addresses.
So what is EBITDA?
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What is EBITDA?
EBITDA is abbreviated to Earning Before Interest, Taxes, Depreciation and Amortization. This is the term used to the pre-tax profit of a business or organization. This profit still includes taxes, loans and is not amortized.
We’re still familiar with the formula for the net profit:
Net Earning = Total revenue – investment costs – interest on loans – taxes
However, not all businesses have the same debt structure and loan structure. Therefore, there are also differences in taxes and assets. From the investor’s point of view, EBITDA is an important basis to evaluate the growth potential of the business in the future.
Formula for calculating EBITDA
To calculate the profit before tax of a certain business, you can use 1 of the following 3 formulas:
- EBITDA = Total revenue after tax + tax + interest + depreciation expense
- EBITDA = Total revenue before tax + interest income + depreciation expense
- EBITDA = EBIT + amortization cost
For example, your revenue in the past year has a total revenue before tax of 10 billion, interest 3 billion loan, depreciation cost 1 billion. It deduced profit before tax would be 14 billion.
The role of EBITDA in business analysis
EBITDA has eliminated fees that affect business performance. Three factors including interest, tax and depreciation have been eliminated by EBITDA.
The reason why interest has been excluded is because the financial structure of each business is not completely the same. As a result, interest expenses also fluctuate. When you borrow more debt, of course, the interest will be higher. In addition, deductions from taxes can also be seen as interest. They are tools for many businesses to use as tax shields.
The individual corporate income tax is also excluded from EBITDA. Because this factor easily affects interest rates and many other expenses. Hence, the actual net profit results are inaccurate.
Depreciation and Amortization
Depreciation is subjective, so it will also be excluded from EBITDA. Through the elimination of many unnecessary factors, it makes comparing profits between businesses or each industry more accurate and easy.
When should EBITDA be used?
EBITDA will be used for businesses with large sums of net worth. With the aim of minimizing the stages of calculating depreciation of fixed assets.
In case you want a more objective assessment of the industry average, you can also rely on the EBITDA results. Also in the field of valuation EV / EBITDA, people also use the method of calculating EBITDA. In some other areas, EBITDA is also applied quite a lot.
Some myths that EBITDA causes investors
The fact that EBITDA has eliminated many important criteria has caused many misunderstandings with investors. Specifically, many people will think EBITDA is a representative outcome for cash flow. But EBITDA only indicates profitability, not cash flow. Because it does not affect working capital flows.
In addition, EBITDA also makes it easy for investors to misjudge the company’s performance. Since a number of factors such as taxes, interest and amortization are removed, the value of EBITDA is often much greater than the net profit.
After all the Fastloans.PH share, hope you know what EBITDA is. It also helps you know when to use EBITDA and when not to include EBITDA results in business reviews.
Refer: EBITDA – Wikipedia