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EBITDA Meaning: Full Form, Formula & Calculation Why It is Important?
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Generally, higher EBITDA indicates stronger profitability. For a meaningful assessment, comparing EBITDA with the company's peers and historical performance is essential.
Amortisation in EBITDA represents the allocation of intangible asset costs over a period of time. Including amortisation in EBITDA helps in providing a clear picture of operational profitability.
EBITDA Multiple is a valuation method. It compares a company's EBITDA to its enterprise value. It is used to assess a company's worth. A higher multiple often indicates a higher valuation.
It offers insights into the company's core profitability. It simplifies comparisons and helps in the valuation of the company. It supports financial decision-making.
Cash flow indicates the actual movement of the money (inflow and outflow) from the company. Conversely, EBITDA focuses solely on operating profitability, excluding interest, tax and non-cash items.
EBITDA is not considered a Generally Accepted Accounting Principle (GAAP) measure. It is considered a non-GAAP metric and is usually used along with the GAAP measures for comprehensive analysis.
Disclaimer: This Article is for information purposes only. The views expressed in this Article do not necessarily constitute the views of Kotak Mahindra Bank Ltd. (“Bank”) or its employees. The Bank makes no warranty of any kind with respect to the completeness or accuracy of the material and articles contained in this Article. The information contained in this Article is sourced from empaneled external experts for the benefit of the customers and it does not constitute legal advice from the Bank. The Bank, its directors, employees and the contributors shall not be responsible or liable for any damage or loss resulting from or arising due to reliance on or use of any information contained herein. Tax laws are subject to amendment from time to time. The above information is for general understanding and reference. This is not legal advice or tax advice, and users are advised to consult their tax advisors before making any decision or taking any action.
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EBITDA is a metric often used in finance. It stands for (E - Earnings, B - before, I - Interest, T - taxes, D - Depreciation, and A - Amortisation). Companies use this method to measure profitability in net income. While applying for a Business Loan, it is important to know the EBITDA meaning. Let us understand what is EBITDA through this article.
What Is EBITDA?
EBITDA stands for Earnings before Interest, Tax, Depreciation, and Amortisation. It is a metric used to provide insights into a company's profitability. EBITDA's full form in finance excludes non-cash expenses, making it another variation of EBIT. It analyses whether the company can generate income from its core business activities. While doing so, it excludes the impact of financing costs, tax obligations and non-cash expenses like depreciation and amortisation.
Investors, analysts and businesses use EBITDA calculations to compare profitability and evaluate the performance of any company.
Why is EBITDA Important?
EBITDA holds a great value in the business for various reasons. Let's study why EBITDA is important:
How is EBITDA Calculated?
The EBITDA calculation is easy. The EBITDA formula is:
EBITDA = Net Income + Interest + Taxes + Depreciation + Amortisation
For a simpler explanation, let's go through the example:
Let's assume a company has:
Net income: Rs 5,00,000
Interest: Rs 50,000
Taxes: Rs 1,00,000
Depreciation: Rs 30,000
Amortisation: Rs 10,000
Let's plug these values into the formula and find out what is EBITDA of the company:
EBITDA = 5,00,000 + 50,000 + 1,00,000 + 30,000 + 10,000
= Rs 6,90,000
In this case, the EBITDA of a company is Rs 6,90,000.
What are the uses of EBITDA?
Now that we know what does EBITDA mean and why EBITDA is important, let us go through the uses of EBITDA:
Assessment of Profitability:
EBITDA is used to assess a company's profitability. It provides a clear understanding of the company's financial health.
Comparative analysis:
It provides a simple and clear analysis of companies from different industries, tax brackets and capital structures.
Debt evaluation:
At Kotak Mahindra Bank, we use EBITDA to assess whether the company can cover interest payments for the business loan.
Valuation:
EBITDA is used by investors and analysts to determine a company's valuation.
EBITDA as a Financial Metric
EBITDA stands for being an important financial metric for several reasons.
Due to these reasons, some may not consider it an accurate measure of profitability. It might also hide the lack of quality in financial judgments.
Nevertheless, EBITDA is an important financial metric most companies use. It provides a precise idea of the earnings before deductions.
What is the EBITDA Margin & Valuation
EBITDA margin and valuation play an important role in financial analysis.
What is EBITDA Margin?
EBITDA Margin represents the percentage of the company's EBITDA concerning its total revenue. It analyses how effectively a company makes a profit from its operations.
EBITDA Valuatio
EBITDA is a fundamental component often used to determine a company's worth or valuation. It simplifies the valuation process.
The formula for EBITDA Margin is:
EBITDA Margin = EBITDA / Aggregate Revenue
For example, if a company’s revenue is Rs 50,00,000 and its EBITDA is ascertained to be Rs 5,00,000, then as per the formula
EBITDA Margin = 5,00,000 / 50,00,000 = 10%.
Also Read: RBI Circular Guidelines on Current Account
Advantages and Disadvantages of EBITDA
EBITDA comes with many advantages and disadvantages.
EBITDA offers a clear view of a company's profitability and helps in assessing operational performances.
It excludes costs like interest, tax, depreciation and amortisation, which are essential for a comprehensive financial picture.
It aids investors and analysts in cross-industry and cross-company comparisons.
It does not consider a company's ability to meet debt obligations. This information is crucial for investors and banks to lend Business Loans.
It helps management make strategic decisions and identify areas of improvement.
It creates confusion since it is not a Generally Accepted Accounting Principle (GAAP) metric.
EBITDA Coverage Ratio
The EBITDA coverage ratio is a crucial metric often used to gauge a company's financial strength. It determines whether the company's pre-tax income can cover all interest-related expenses like lease payments.
The EBITDA coverage ratio formula is expressed as:
EBITDA Coverage Ratio = (EBITDA + Lease Payments) / (Interest Payments + Principal Payments + Lease Payments).
If the value comes equal to greater than 1, it indicates the company's financial stability and ability to meet its financial obligations.
Also Read: Cancelled Cheque: How to Write it
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