EBITDA is an acronym for Earnings Before Interest, Taxes, Depreciation, and Amortization.
While conducting financial analysis, the EBITDA to sales ratio used as a financial metric to know the company’s operational efficiency.
EBITDA margin is calculated by dividing earnings before interest, tax, depreciation and amortization by total sales.
It’s used as a measure to compare two companies with different debt, tax and assets profiles.
Basically you take out depreciation and amortization expenses as well as taxes and debt costs dependent on the capital structure out of profit after tax to get EBITDA.
It’s a very good measure to know the company’s core profitability. This means EBITDA tells investors how efficiently a company operates and how much of its earnings are attributed to operations.
EBITDA helps financial analysts to compare a company’s profitability with others after eliminating the effects of financing and depreciation.
The earnings before interest, tax, depreciation and amortization of a company represents its cash profit from operations.
In general, company’s do not report earnings before interest, tax, depreciation and amortization figures separately in the income statement. If a company doesn’t report EBITDA, it can be easily calculated from its income statement.
Here is the formula to calculate EBITDA;
EBITDA = Net profit after tax + Taxes + Interest Expense + Depreciation & Amortization
Net profit after tax is the last line item in the company’s income statement which is derived after taking out all the expenses out of total revenue of the company or business.
Interest is the amount that the company has incurred due to loans provided by a bank or similar third-party.
Taxes are the expenses the company has incurred due to the tax rates applicable based on the country from where it operates.
Depreciation is a non-cash expense referring to the gradual reduction in value of a company’s assets due to use in business.
Amortization is a non-cash expense referring to the cost of intangible assets over time.
Earning before interest, tax, depreciation and amortization (EBITDA) is used by financial analysts in the case of capital intensive industries.
Some fundamental analysts don’t consider EBITDA as a measure to know a company’s efficiency. They think that depreciation is a real cost which can not be ignored.
Example: How to calculate EBITDA
Suppose a company XYZ limited generates Rs 1,000 crore in revenue and incurs Rs 400 Crore cost of goods sold and Rs 200 Crore in overhead.
Depreciation and amortization expenses are Rs 100 crore
Interest expenses is Rs 50 Crore
Tax is Rs 62.5 Crore
Profit after tax = 1000 – 400 – 200 – 100 – 50 – 62.5 = Rs 187.5 Crore
EBITDA = PAT + taxes + Interest + Depreciation and amortization = 187.5 + 62.5 + 50 + 100 = Rs 400 Crore
As earnings before interest, tax, depreciation and amortization is a measure of profitability, the higher is better.
You will not find EBITDA showing in the company’s income statement. You need to calculate it by using the above formula. Some companies show their earnings before interest, tax , depreciation and amortization in their press releases.
Earnings before interest, tax, depreciation and amortization margin will show you the cash profit a company makes during a year or quarter. You can use following formula to calculate EBITDA margin;
EBITDA margin = Earnings before interest, tax, depreciation and amortization / Total Revenue
For example, if a company has an EBITDA of Rs 80 crore while its total revenue is Rs 800 Crore, then the EBITDA margin is 10% [(80/800)*100].
Remember, earnings before interest, tax, depreciation and amortization alone does not reveal how profitable the company is. You need to use profitability ratios to find out a company’s efficiency to make money.