EDITDA, What is EBITDA Margin, EBIT? | What is EBITDA in stock market | EBITDA v/s Operating Income v/s Revenue

While going through annual report or P&L statement, we often find "EBITDA" & "EBIT" mentioned. 

Earnings before Interest Tax Depreciation & Amortization(EBITDA) is an important financial term in corporate world that helps investor understand company's performance at operational level.

Now let us breakdown this complex financial term EBITDA.

 

WHAT IS EBITDA

EBITDA stands for 

E - Earnings 

B - Before 

I - Interest 

T - Tax

D - Depreciation 

A - Amortization 

 Earnings: In financial terms, it is profit from operating activities (Gross Profit) and can be calculated by subtracting Total Expenditure from Total Income.

 Interest: Expense that is incurred when a company has borrowed money (loan/debt) in order to expand/continue its business operations.

 Amortization and Depreciation: These are reduction in the value of tangible and intangible assets of the company every year.

CALCULATION OF EBITDA & EBIT

EBITDA is calculated by adding Interest, Tax, Depreciation & Amortization expenses to Net Profit for the financial year.

EBIT is calculated by adding Interest and Tax expenses to Net Profit for the financial year.

to understand 

EBIT

 EBIT is also known as operating income, an income that is generated from company's operations.

 EBIT stands for 

E - Earnings 

B - Before 

I - Interest 

T - Tax

Example of Company X

Let us see P&L statement of this company X

Hence, EBITDA will be 1.5 Cr.

EBITDA Margin

 EBITDA margin is equal to EBITDA/Net Sales (Revenue). It is a calculation of company’s earnings/operating profits as a percentage of its total revenue.

Let us take some example of FMCG sector:

   Britannia had EBITDA of 2,412 Cr. Net Sales of 15,531 Cr. Dividing both we get EBITDA margin of 15.5%.

 

WHAT DOES EBITDA MARGIN TELLS AN INVESTOR ???

 In this example, we saw an EBITDA margin of 15.5%. This tells us that remaining 84.5% of net sales are operational expenses (i.e.. cost of goods sold).

Higher EBITDA margins, higher the earnings (profits) lower the operating expenses. If the EBITDA margin of any company is increasing, it indicates that either company is working to lower its operating expenses or net sales increased by high volumes.

 

HOW DOES AN  INVESTOR USE EBITDA??

 Investors use EBITDA to measure the total earnings made by the company during the financial year. It shows cash flow generated by company's core operations. For example, Maruti Suzuki Limited manufactures and sells cars. So the core operation of Maruti Suzuki is to sell manufactured cars. EBITDA for this case would be profit by selling cars. Many investors often mistake EBITDA to Net Sales.

YES, true

How EBITDA is different from net sales??? Let us observe both the definations carefully.

Net Sales: Revenue generated from core operations.

EBITDA: Profit generated from core operations. 

ADVANTAGES OF USING EBITDA & EBITDA MARGIN

 ·         It gives the knowledge of cash flow generated from ongoing operations. Britannia Industries Limited had an EBITDA of 2,405.8 Cr for the last financial year. This shows that Britannia generated 2,405.8 Cr from operations. Maruti Suzuki Limited had an EBITDA of 10,721.7 Cr for the last financial year. This shows that Maruti Suzuki Limited generated 10,721.7 Cr by manufacturing and selling cars last year.

·EBITDA make it easy to compare peer companies on operational level. Since EBITDA is annual estimated earnings of the company therefore it is often used during acquisitions and mergers. Companies may use different and complex accounting policies but EBITDA is always measured whenever dealing with operations/manufacturing.

·It indicates the health of business. A continuous J curve (growth curve) in EBITDA shows consistent increase in earnings of a company. This situation may arise either by growth in sales volume or decrease in cost of goods sold (COGS). Mostly increase in sales volume is one of the prominent reasons for growth in EBITDA.

·It shows necessary expenses for day to day running of operations. Jubiliant Foodworks Limited had an EBITDA of 939.62 Cr and PAT (Profit After Tax) of 322.8 Cr. We get PAT/EBITDA as 34.35%. It means only 34.35% of gross earnings turned to real profit for the company.

·It makes it easy to compare peer companies. Ashok Leyland had an EBITDA of 1,295.65 Cr, Maruti Suzuki had an EBITDA of 10,721.7 Cr and Tata Motors observed an EBITDA of 731.9 Cr. Operationally, Maruti Suzuki is best among these irrespective of tax and debt burden on each of them.

DISADVANTAGES OF USING EBITDA & EBITDA MARGIN

·         It gives low knowledge about interest burden on a company. In the above case of auto sector, we saw some of the top companies like Maruti Suzuki, Ashok Leyland and tata motors. Now let us see debt burden on each of these:

Maruti Suzuki: 149.6 Cr
Ashok Leyland: 632.36 Cr
Tata Motors: 18,639.63 Cr
·         EBITDA has nothing to do with investing and financing activities of a company. It only shows company’s profit from operating activities.
 
·         EBITDA does not tells about the tax burden on a company. This statement:
·         It ignores capital expenditure. We do not get any information about money spent by a company or organization on acquiring or maintaining fixed asset such as land, building and equipment. Jubiliant Foodworks Limited observed an EBITDA of 939.62 Cr. They mentioned in their annual report that they opened 22 new stores of Domino’s pizza. But in this statement:

 

WHY DO TOP OFFICIALS/MANAGEMENT PREFER EBITDA OVER OTHER RATIOS ???

 To understand this let us take an example of company X. Company X was a debt-free company with an EBITDA of 14 Cr and PAT of 2.5 Cr. Company kept on increasing its Sales, EBITDA, PAT. A year later, company X was acquired by company Y. Since it was a leveraged buyout, company X had to pay 0.9 Cr as interest on loan sanctioned. The new management was good and progressive, again increasing sales and working on lowering the cost of goods manufactured. A year passed on, let us again go into dept with the company’s financials. EBITDA rise to 17 Cr and PAT dip to 2.13 Cr. As an investor, we might say that company is losing its profitability.

What if I say that company’s profitability has increased!

NO, that’s not true.

YES, it’s true!

Going deep into financials we found out that this year PAT stood at 3.03 Cr but now interest expense on loan sanctioned is still to be paid. So (3.03-0.9) = 2.13 Cr becomes the PAT. Now, just take a look at EBITDA. EBITDA shows growth from 14 to 17 Cr (an increase of 21.2%). EBITDA gives us to-the-point knowledge about company’s earnings from core operation. PAT may fool us at appoint, but EBITDA show the true picture. Therefore, EBITDA is preferred by business owners, top officials, management over any other ratio when it comes to business operational profitability.

 

INVESTOMANTHAN’S ADVICE

Reading Annual report is very important. It will give good in-depth knowledge about a company’s operation. Don't rely on EBITDA only go for other fundamental ratio analysis like PE, PB, debt to equity, etc.

Comment us below if you need any more such ratio.