The term EBITDA stands for Earnings before Interest, Taxes, Depreciation, and Amortization. EBITDA is used to measure any particular company’s overall performance in terms of financial aspects. It depicts the profitability and is a good alternative for simple earning and net incomes in many situations. The income statement are used to find the earning tax and interest figures while cash flow statements are used to find the amortization and depreciation figures.
How to calculate the EBITDA?
To calculate EBITDA the basic method is to start with the EBIT which stands for Earnings Before interest and Tax. EBIT is also known as operating profit. After calculating this one can add the amortization and depreciation to it as well.
The formula for EBITDA is given as-
- EBITDA = Net income+ Interest + tax + Depreciation + Amortization
- EBITDA = Operating Profit + Depreciation Expense + Amortization Expense
How can EBITDA be misleading?
Now many times the cost of capital investments can be stripped out by the EBITDA. The capital investments may include things like property, equipments or even plants. EBITDA also sometimes ignore that expense which are related to the debt since they add back the interest expense and tax to the earnings itself. But if after this, EBITDA are considered to be a very precise measurements technique to insure the financial performances of any corporate sector. This is because through EBITDA even if the accounting and financial deduction have been made, they are able to show the precise earnings. Also there is no such legal requirement to show the EBITDA for the companies.
How are EBITDA helpful?
EBITDA is basically a standard that helps in measuring the operating performance of any company. It is often seen as a proxy in place of the cash flow from the entire operation of the company.
The EBITDA are usually used by the financial analysts to measure the operating performance and the profitability of a particular company.
By the help of EBITDA, an analyst can focus on the results of the decisions made in terms of operating. They can do this by excluding the effect of the decision which are usually based on non operating function for example the interest expenses which is a financial decision or the tax rates which is a governmental decision. They are also able to omit the effects of some non cash items which are large like the depreciation or amortization which again is an accounting decision. Now since these non operating effects are unique to every company, by decreasing their effects, the investors are allowed to emphasize more on the operating profitability which is a parameter for measuring performance by the EBITDA. This type of analysis plays an important role when it come to making comparison of companies which are similar in the same industry or for comparing companies that have tax brackets which are different.
So after all the comparisons, if the EBITDA coverage ratio is higher than it means that the company is more able to repay its liabilities. And on the other hand a lower coverage ratio represent the difficulty a company may face while repaying its obligations.