šš¼ everyone,
Of all the financial acronyms that cause widespread confusion and bamboozlement (side note: I donāt use the word ābamboozlementā enough), EBITDA has to be amongst the top ten, surely?
If this is true then I dread to think about what people thought of me during my early career.
Anyway, all that said, letās get to grips with EBITDA.
(Quickly) Explainedā¦
EBITDA stands for Earnings Before Interest, Taxes, Depreciation, and Amortisation (Iāll explain these terms below).
In simple terms, EBITDA gives an idea of how much cash a company is generating from its operations without considering the effects of financing and accounting decisions.
It's commonly used by investors and analysts to evaluate a company's financial health and compare it to other companies in the same industry.
āEBITDAā š terms:
š°Earnings
Normally, this is net income.
Net income is the total revenue youāve generated from sales, minus the total amount you deduct as a legitimate business cost.
Before
The āBā stands for ābeforeā. A company reports their EBITDA "before" certain expenses such as restructuring costs, stock-based compensation, or other one-time expenses.
Interest
The interest charged when repaying any debt / loans.
šø Taxes
In the context of EBITDA, taxes refer to the taxes (e.g. corporation tax) that a company is required to pay on its earnings. These are set at a state, city or country level typically.
š Depreciation
When you use tangible (physical) assets ā such as cars š or machinery āļøā over time, they fall in value. EBITDA adds back this loss in value.
Let's say a manufacturing company purchased a piece of machinery for $100,000 that is expected to last for 10 years. The company can't expense the entire $100,000 in the year of purchase because the machine is expected to last for several years and will generate income over its useful life. Instead, the company depreciates the asset over its useful life, which means it spreads the cost of the machine over 10 years.
Assuming straight-line depreciation, the company would depreciate the machine by $10,000 per year (i.e., $100,000 divided by 10 years). So, in the first year of owning the machine, the company's income statement would show a depreciation expense of $10,000.
Amortisation š¤
the āAā leaves many people scratching their head, as frankly itās not a term referenced all that often.
In EBITDA, Amortisation refers to expensing intangible assets.Ā
Intangible assets are non-physical assets e.g. copyrights, patents, trade names etc. Intangible assets are typically complex compared to fixed assets, but they are included on a companyās balance sheet and have a multi-period useful life (in that they could be used for many years).
āļø Then you might hear the occasional mention of 'Adjusted EBITDA'
Adjusted EBITDA is simply EBITDA with further adjustments made to better reflect a company's operating cash flow. These adjustments can vary from company to company, but they typically exclude items like one-time expenses - an example might be a one off legal settlement cost.
EBITDAā¦in 31 seconds!
š¢ How to calculate EBITDA
EBITDA = Net Income + Taxes + Interest Expense + Depreciation & Amortisation
Example šš¼
šŗš»Why are companies obsessed with EBITDA as a metric?
Companies generally care about EBITDA because it provides a better view of actual business health. And, how well its business model is working:
It removes financing variables (like interest on loans) to provide a clearer picture šµ
It only accounts for necessary expenses for the day-to-day running of the business
It represents the cash flow generated by ongoing operations
And it gives a good sign of how well the business is able to generate profits
It is also important to note that when a company wants to sell, the selling price is often a multiple of EBITDA.
Thanks as always for reading š if you found this helpful and enjoyed the post, Iād be super grateful if you could hit the ā¤ļø below - thank you!
DISCLAIMER:Ā None of this is financial advice. Concepts of Finance newsletter is strictly for educational purposes.
Great article! šš
Will send people here in the future anytime they ask me to explain EBITDA š