Hey All,
This time it is not about Money that I will be talking about. But rather today we have something very different and I hope you will find this as an intresting and knowledgeable topic. Now before we get started it is imperative to know what EBITDA stands for. So here is the fullform of it - "Earnings Before Interest, Taxes, Depreciation, and Amortization." Almost all the companies uses EBITA as a financial metric because it helps measure a company’s operational performance without the impact of financing decisions, tax structures, or non-cash expenses. As you can see from its full form - EBITDA tells you how much money a company makes from its core business operations, before considering:-
- Loan interest
- Taxes
- Depreciation
- Amortization
What is EBITDA & Why it is Important...
In all we can think EBITDA as a business performance card. The next question that comes to ones mind is that what is a good EBITDA number for an organization. Well there’s no single good EBITDA number and what is a good number depends on the company’s size, the industry it operates in, and the businesses it is being compared with. While doing my reading about EBITDA - I also found out this - Simple Rule of Thumb - which is as follows::
A Good EBITDA is one that is:
✔️ Positive
✔️ Growing
✔️ Better than competitors
✔️ Healthy for that industry
Therefore it would be correct to say that a growing EBITA is healthy for business and where as a decilining EBITDA is like a warning sign.
Growing EBITDA Year-on-Year == Good business
Declining EBITDA == Warning Sign
Let us now looking into an example in deriving an EBITDA number randomly for any organization.
| Step | Component | Amount (₹) | Explanation |
|---|---|---|---|
| 1 | Net Income | 10,00,000 | Final profit after considering all the expenses |
| 2 | Add: Interest Expense | 50,000 | Cost of borrowed money i.e. the interest paid |
| 3 | Add: Taxes | 1,00,000 | Government taxes paid |
| 4 | Add: Depreciation | 75,000 | Wear & tear of assets |
| 5 | Add: Amortization | 25,000 | Cost of intangible assets |
| EBITDA | 1,250,000 | Core operating earnings |
As you can see from the above table EBITDA is able to clearly tell the company’s operating performance by removing the impact of financing costs, tax structures, and non-cash expenses. This makes it SIMPLE to understand how efficiently the business is generating earnings purely from its core operations. Now let us look into Net Income aspect which is the organizations final profit after all expenses are deducted. In more simple terms::
EBITDA - shows how well the business operates
Net Income - shows how much the business truly earns
Here is a quick comparion - EBITDA vs Net Income
| EBITDA | Net Income |
|---|---|
| Focuses on operations | Focuses on final profit |
| Excludes interest & taxes | Includes interest & taxes |
| Excludes depreciation | Includes depreciation |
| Good for comparison | Good for actual profitability |
To sum it up, EBITDA shows operating performance, while Net Income showcases the true profitability of the company. I have also noticed that nowdays EBITDA is losing center stage and organizations are moving towards tracking FCF - Free Cash Flow. More on this maybe in my next post. For now this this should be it for todays post on - "Finance - What is EBITDA & Why it is Important - Lets Explore..." Let me know in the comment section below if there is any follow up questions around EBITDA? Happy Wealth Building & Investing... Cheers
Image Source: Facebook - Accounting Knowledge Concepts
Best Regards
Paras
PS:- None of the above is a FINANCIAL Advice. Please DYOR; Do your own research. I have a personal interest in blockchain, stocks, and cryptocurrencies and actively invest in emerging projects.