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· Posted on
February 21, 2024

SOS: What’s EBITDA?

No clue what the frickle frackle EBITDA is? Let's spell it out.

What's the key learning?

  • EBITDA stands for earnings before interest, taxes, depreciation and amortisation.
  • It’s often used when companies are talking about their profits.
  • EBITDA takes out the company’s expenses that are not related to the operations of the company day to day.
  • This gives investors an overall view of a company’s operating performance.
  • Investors will use EBITDA as a standard measure to compare companies against each other.

Got no f**king clue what companies are talking about during earnings season?

You’re not alone. 

Opening a company’s annual report can feel like you’re trying to understand a whole new language. 

One with lots of acronyms!

While each business and each industry has their own unique set of metrics, there are a number of metrics that remain consistent across all businesses. 

That’d be things like revenue, net profit (or loss!), profit margins and of course cash flow.

But there’s also a metric called EBIT, which is a way to assess a company’s profitability from its core operations.

What’s EBITDA?

EBITDA stands for earnings before interest, taxes, depreciation and amortisation - what a mouthful!

It’s often used when companies are talking about their core profits. 

In a business, you’ve got expenses that relate to day to day activities like employee wages, rent, material costs etc.

And you’ve also got expenses that aren’t directly related to how a business makes money. Think interest on debt, depreciation of machinery, taxes etc.

EBITDA takes out expenses that are not related to the day to day operations of the company to understand if the company is covering their operational expenses with their operational revenue.

How’s EBITDA calculated?

EBITDA = Net Profit (or Loss) + Interest + Taxes + Depreciation & Amortisation

EBITDA gives investors an overall view of a company’s operating performance - without taking into account stuff like taxes and debt (which can vary significantly from year to year).

Hold up - why is interest, tax, depreciation and amortisation added into this formula?

When calculating EBITDA, you start with net profit. But this number includes interest, taxes, depreciation, and amortisation subtracted from it. 

With the EBITDA metric, we add these items back in. This seems strange at first glance, but makes sense. 

By adding these numbers back in, you are able to measure a company's earnings generated solely from its business operations, without the influence of how it is financed, how it depreciates assets, or how it handles taxes.

Investors will use EBITDA as a standard measure to compare companies against each other.

This way, if company X has 10 tractors and company Y has 114 cranes, you can still compare the two because you’re only looking at their profitability.

 

EBITDA shouldn’t be looked at alone…

For example, if two companies have the same EBITDA but one has a lot more debt, that difference in financial risk won’t be visible by looking at EBITDA alone.

That’s why EBITDA frequently receives criticism because it can show an inaccurate and potentially misleading representation of a company’s actual cash flow profile.

So it’s important to use EBITDA alongside other performance measures (like the Balance Sheet or Cash Flow Statement) so that you can get a well-rounded view of a company’s financial health and performance.

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