ebitda

EBITDA

This post will take a dive into the concept of EBITDA – an important metric in private business valuation and analysis.

The EBITDA stands for Earnings before Interest, Taxes Depreciation and Amortization. This metric can be seen as a proxy for cashflows from a company’s operations, and hence, used to analyze a company’s operating performance.

The EBITDA metric is a variation of operating income metric (EBIT – Earnings before Interest and Taxes) that excludes non-operating expenses and certain non-cash expenses. The purpose of these deductions is to remove the factors that business owners have discretion over, such as debt financing, capital structure, methods of depreciation, and taxes. Thus, it can be used to showcase a firm’s financial performance without accounting for its capital structure and discretionary decisions by management (i.e. accelerated depreciation)

 

EBITDA is calculated as follows:

EBITDA = Net Income + Interest Expense + Taxes + Depreciation and Amortization.

Or,

EBITDA = Operating profit + Depreciation and Amortization.

Or in simpler terms, from the company’s revenue, you then minus all expenses to get to net income / net profit, but EBITDA doesn’t go all the way down to net income, it stops BEFORE the expenses of interest, taxes, depreciation and amortization.

Interest Expense: Interest expense is added back to Net Income as it depends on the financing structure of a company. The higher the debt in a company’s capital structure, the higher its interest expense. Hence, it is easier to compare the relative performance of companies by adding back interest and ignoring the impact of capital structure on the business. One must also note that interest payments are tax-deductible.

Taxes: Taxes depend on the region that a company operates in. Further, they are not affected by the financial performance of the company, hence, they are added back to enable the comparison of companies that work in different geographies.

Depreciation and Amortization: The depreciation expense is based on a portion of the company’s tangible fixed assets deteriorating. Amortization expense is incurred if the asset is intangible. Further, they depend on the historical investments the company has made and not on the current operating performance of the business. These metrics are influenced by factors such as the useful life of the assets involved, the salvage value and lastly the method used to depreciate or amortize the assets (often taking advantage of higher depreciation to lower taxes). Thus, they are excluded from the EBITDA.

EBITDA Australia

The Use of EBITDA in Valuation:

The EV/EBITDA multiple (Enterprise Value/Earnings before Interest, Taxes, Depreciation and Amortization multiple) is a commonly used metric in valuation. It helps analysts compare different companies in the same industry as well as compare the subject company with its industry to understand if the company in question is undervalued or overvalued.

EBIT versus EBITDA

EBITDA is used as a proxy for cashflow to analyze and compare the profitability between different companies in the same industry as it eliminates financing effects and accounting decisions. For a company or an industry which requires relatively low capital expenditures to maintain its operations, the EBITDA may be the metric to use.

However, when one looks at a capital-intensive industry or company, such as mining and infrastructure, EBITDA turns out to be meaningless. This is mainly as due to the extensive amount of capital spending required in these industries, and thus, due to a large depreciation and amortization expense, the EBITDA and the cashflow for the industry or company would be very different. In such a case, the using of EBIT incorporates the significant investment into fixed assets required to generate the operating income of the company.

Example:

Let’s assume the company ABC has the following income statement:

Revenue $200
Less: COGS $40
Gross Profit $160
Less: Operating Expenses $50
Operating Profit $110
Less: Interest Expense $20
Earnings Before Taxes $90
Less: Tax Expense $40
Net Income $50

Additional information: Depreciation of $20 and Amortization expense of $20 included in the operating expenses. Calculate the EBITDA for Co. ABC.

 

EBITDA = Net Income + Interest Expense + Taxes + Depreciation and Amortization.

Thus, EBITDA = $50 + $40 + $20 + $20 + $20

EBITDA = $150

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