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Earnings before interest, taxes, depreciation, and amortization

From Wikipedia, the free encyclopedia

A company's earnings before interest, taxes, depreciation, and amortization (commonly abbreviated EBITDA,[1] pronounced /bɪtˈdɑː/,[2] /əˈbɪtdɑː/,[3] or /ˈɛbɪtdɑː/[4]) is an accounting measure calculated using a company's earnings, before interest expenses, taxes, depreciation, and amortization are subtracted, as a proxy for a company's current operating profitability (i.e., how much profit it makes with its present assets and its operations on the products it produces and sells, as well as providing a proxy for cash flow).

Though often shown on an income statement, it is not considered part of the Generally Accepted Accounting Principles (GAAP) by the SEC.[5]

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Transcription

Welcome to the "Finance Storyteller" series. I am here to make business strategy and finance enjoyable and easier to understand. In this video we are going to cover the financial terms EBIT and EBITDA. Let me give you some context, so you know where EBIT and EBITDA fit in. There are three financial statements: The balance sheet, an overview what we own and what we owe at a point in time. The income statement, an overview of the profit or income that you generate during a period. And... The cash flow statement, an overview of how much cash you generate, and where you spend your cash during a period. EBIT and EBITDA are income statement metrics. EBIT is Earnings Before Interest and Taxes. EBITDA is Earnings Before Interest, Taxes, Depreciation and Amortization Earnings is the same as income or profit. The word "before" suggests that we are excluding certain items from our operational performance metric. Interest is excluded, as it depends on your financing structure. How much did you borrow, and at what interest rate? Taxes are excluded, because it depends on the geographies that you work in. Depreciation and amortization are sometimes excluded, because they depend on the historical investment decisions that a company has made, not the current operating performance. Let me show you an overview of an income statement, or profit and loss statement, so you know where EBITDA and EBIT fit in. Revenue minus Cost Of Sales equals Gross Profit. Gross Profit minus S,G&A and R&D equals EBITDA. EBITDA minus Depreciation & Amortization equals EBIT. EBIT minus Interest and Taxes equals Net Income. Please be aware that different companies use different terminology, so what you see here might be different from what your company is using. Also, not every company reports both on EBITDA as well as EBIT. EBITDA is commonly used as a metric in very capital-intensive industries like manufacturing, trucking, oil and gas, and telecom. Service-heavy industries like consultancy wouldn't even bother splitting out the two. What is depreciation? How does that work? Let's assume you want to buy a truck for your company to deliver your products. You spend $100,000 to buy it. What happens on your financial statements is that cash goes down by $100,000, and your fixed assets (or "plant and equipment") go up by $100,000. It would be incorrect to book the full $100,000 straight away as a cost for the current year, because you are going to use the truck for multiple years. That's when depreciation comes up. Let's assume that the truck has a useful economic life of 5 years, and has no residual value. If you use straight-line depreciation, you book $20,000 per year in depreciation. The value of the asset on the balance sheet goes down by $20,000 per year, and in the income statement you charge this $20,000 as an expense. Let's look at an example of using EBIT and EBITDA in financial reporting. I took the 2015 annual report of the Maersk Group, a company headquartered in Denmark and operating globally. They report in US$. Their best known business is Maersk Line, which is the world's largest container shipping company. They are also active in areas like oil and gas, terminals and drilling. Maersk's revenue in 2015 was 15% lower than the year before, and net income (or net profit) was down by 82%. But is net income the most relevant way to measure their profitability performance? Maersk gives you the choice to also evaluate profitability at other levels: EBIT was down 68%, and EBITDA was down 24%. Depreciation and amortization are sometimes referred to as "fixed costs", they don't go up and down with the number of units that you sell, but they are driven by the investments that you have made, and the number of years you use those assets. In the case of a company like Maersk, which operates in a capital intensive industry, depreciation is a huge number, 8 billion USD in 2015, almost 20% of revenue. Looking at the EBITDA as well as the EBIT performance gives you more information than looking at EBIT alone. What do business and finance people use EBITDA for? It is often mentioned as part of M&A (or Mergers & Acquisitions) news. A quick-and-dirty way to calculate the value of a company is by using a multiple of EBITDA. This can help you to get to a ballpark number, but I would advise to always do a more thorough analysis and a more thorough valuation of a company, as there are a lot of "ifs" connected to using an EBITDA multiple: you are assuming the profitability and the industry does not change, you exclude the impact of working capital (which could go up dramatically for a fast-growing company), and you exclude the cash that you need for capital expenditures on an ongoing basis for the company. In summary: what is EBIT and EBITDA? EBIT is Earnings Before Interest and Taxes EBITDA is Earnings Before Interest, Taxes, Depreciation and Amortization. Both EBIT and EBITDA are measures of profitability, along with terms like gross profit and net income. EBITDA is a meaningful metric for capital-intensive industries. I hope you have enjoyed this "Finance Storyteller" video! Thank you for watching! Please let me know what you think in the comment section, and connect on my blog, Linked In, Twitter or YouTube.

Contents

Usage

Although EBITDA is not a financial measure recognized in generally accepted accounting principles, it is widely used in many areas of finance when assessing the performance of a company, such as securities analysis. It is intended to allow a comparison of profitability between different companies, by discounting the effects of interest payments from different forms of financing (by ignoring interest payments), political jurisdictions (by ignoring tax), collections of assets (by ignoring depreciation of assets), and different takeover histories (by ignoring amortization often stemming from goodwill). EBITDA is a financial measurement of cash flow from operations that is widely used in mergers and acquisitions of small businesses and businesses in the middle market. It is not unusual for adjustments to be made to EBITDA to normalize the measurement allowing buyers to compare the performance of one business to another.[6]

A negative EBITDA indicates that a business has fundamental problems with profitability and with cash flow. A positive EBITDA, on the other hand, does not necessarily mean that the business generates cash. This is because EBITDA ignores changes in working capital (usually needed when growing a business), in capital expenditures (needed to replace assets that have broken down), in taxes, and in interest.

Some analysts do not support omission of capital expenditures when evaluating the profitability of a company: capital expenditures are needed to maintain the asset base which in turn allows for profit. Warren Buffett famously asked, "Does management think the tooth fairy pays for capital expenditures?"[7]

Margin

EBITDA margin refers to EBITDA divided by total revenue (or "total output", "output" differing "revenue" by the changes in inventory).[8]

Misuse

Over time, EBITDA has mostly been used as a calculation to describe the performance in its intrinsic nature, which means ignoring every cost that does not occur in the normal course of business. In spite of the fact this simplification can be quite useful, it is often misused, since it results in considering too many cost items as unique, and thus boosting profitability. Instead, in case these sort of unusual costs get downsized, the resulting calculation ought to be called "adjusted EBITDA" or similar.[9]

Because EBITDA (and its variations) are not measures generally accepted under U.S. GAAP, the U.S. Securities and Exchange Commission requires that companies registering securities with it (and when filing its periodic reports) reconcile EBITDA to net income in order to avoid misleading investors.[7]

Variations

EBITD

Earnings before interest, taxes, and depreciation (EBITD or EBDIT), sometimes called profit before depreciation, interest, and taxes (PBDIT), is an accounting metric.[10] Some people find it useful to know this value for a business. On the other hand, some businesses may emphasize this value in publicity or reports to investors, instead of the GAAP or other standard earnings or income value.

In finance, EBITD is sometimes used in capital budgeting calculations as a starting point in order to create templates that can be easily changed to observe the effects of changing variables (such as tax rates, allowances for inflation or changes in depreciation methods) on a net present value (NPV) or internal rate of return (IRR) value, and thus, the viability of a potential investment or project.[11]

EBITA

Earnings before interest, taxes, and amortization (EBITA) refers to a company's earnings before the deduction of interest, taxes, and amortization expenses.[12] It is a financial indicator used widely as a measure of efficiency and profitability.

EBITA margin can be calculated by taking the Profit Before Taxation (PBT/EBT) figure as shown on the Consolidated Income Statement, and adding back Net Interest and Amortization. Often, Amortization charges are zero and therefore EBIT = EBITA.

EBITA has been cited by buyside investors as a useful metric to be used as a replacement for, or in conjunction with, EBITDA multiples, as corporations continue to present increasing levels of intangible-based amortization.

EBITDAR

Earnings before interest, taxes, depreciation, amortization, and restructuring or rent costs (EBITDAR) is a non-GAAP metric that can be used to evaluate a company's financial performance.

EBITDAR can be of use when comparing two companies in the same industry with different structure of their assets. For example, consider two nursing home companies: one company rents its nursing homes and the other owns its homes and thus does not pay rent but instead has to make capital expenditures that are not necessarily of the same order of magnitude as the depreciation. By looking at EBITDAR, one can compare the efficiency of the companies' operations, without regard to the structure of their assets.

Some companies use an EBITDAR where "R" indicates "Rinel Costs". While this analysis of profits before restructuring costs is also helpful, such a metric should better be termed "adjusted EBITDA".

Related to EBITDAR is "EBITDAL", "rent costs" being replaced by "lease costs".

EBIDAX

Earnings Before Interest, Depreciation, Amortization and Exploration (EBIDAX) is a non-GAAP metric that can be used to evaluate the financial strength or performance of oil, gas or mineral company.[13]

Costs for exploration are varied by methods and costs. Removal of the exploration portion of the balance sheet allows for a better comparison between the energy companies.

OIBDA

Operating income before depreciation and amortization (OIBDA) refers to an income calculation made by adding depreciation and amortization to operating income.

OIBDA differs from EBITDA because its starting point is operating income, not earnings. It does not, therefore, include non-operating income, which tends not to recur year after year. It includes only income gained from regular operations, ignoring items like FX changes or tax treatments.

Historically, OIBDA was created to exclude the impact of write-downs resulting from one-time charges, and to improve the optics for analysts comparing to previous period EBITDA. An example is the case of Time Warner, who shifted to divisional OIBDA reporting subsequent to write downs and charges resulting from the company's merger into AOL.

In each case OIBDA, OIBTDA, and EBITDA are proxies for analyzing the cash a firm can generate from operations regardless of capital structure and taxes, and is therefore very useful as a tool in designing restructurings, mergers and acquisitions, and recapitalizations, and for valuing firms on a TEV (total enterprise value) basis.

See also

References

  1. ^ "EBITDA - Financial Glossary". Reuters. 2009-10-15. Archived from the original on 2012-06-30. Retrieved 2012-02-09.
  2. ^ Professional English in Use Finance, Cambridge University Press
  3. ^ "Pronunciation of ebitda - how to pronounce ebitda correctly". Howjsay.com. 2006-10-29. Retrieved 2012-01-21.
  4. ^ "EBITDA - alphaDictionary – Free English On-line Dictionary". Alphadictionary.com. 2001-05-03. Retrieved 2012-01-22.
  5. ^ "Frequently Asked Questions Regarding the Use of Non-GAAP Financial Measures". www.sec.gov. Division of corporation finance, SEC, USA. Retrieved 24 January 2018.
  6. ^ "Adjusted EBITDA Definition - Free Tool - ExitPromise". 4 April 2014.
  7. ^ a b "Top Five Reasons Why EBITDA Is A Great Big Lie". Forbes. 2011-12-28. Retrieved 2012-11-15.
  8. ^ "What is EBITDA?". BusinessNewsDaily. 2013-05-09. Retrieved 2014-11-15.
  9. ^ "EBITDA Calculations and Reconciliation". TigerLogic. Retrieved 2014-02-08.
  10. ^ NASDAQ: Earnings before interest, taxes, and depreciation (EBITD)
  11. ^ Frino, Hill & Chen (2009), "Introduction to Corporate Finance" 4th ed.
  12. ^ "EBITA". Retrieved 2014-11-30.
  13. ^ "Earnings Before Interest, Depreciation, Amortization and Exploration (EBIDAX)". Investopedia. 2010-06-28. Retrieved 2018-02-12.

Further reading

External links

This page was last edited on 19 September 2019, at 07:11
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