If you’ve been investing in ASX shares long enough, you’ve probably faced your fair share of ‘finance jargon’. EBITDA is one of the worst.
What does EBITDA mean?
EBITDA means Earnings, Before, Interest, Taxes, Depreciation & Amortisation.
EBITDA is just a fancy way of saying profit (which is also called ‘earnings’) excluding a heap of expenses. The higher EBITDA figure, the better — because the company is making more money.
If you’re comparing two different companies for investment, EBITDA can improve the comparison because depreciation and other charges have been excluded from profit. Meaning, it tells you how much profit the company makes before the company pays interest on debt, the Government takes its taxes and depreciation is deducted. This might help you determine if the company is a good investment.
What’s the difference between EBITDA and EBIT?
You’ve probably guessed it already, but EBITDA is the same thing as EBIT but with ‘DA’ added on the end. So, if we can find EBIT and ‘DA’ all we have to do is add them together to find EBITDA!
What is EBITDA used for?
EBITDA is often used by stock market analysts, companies on the stockmarket, bankers and financial journalists. Why?
- Analysts like to use EBITDA because it excludes costs like depreciation, interest and taxes. Therefore, they say it provides a ‘clearer picture’ of the company’s earnings.
- Companies like to use the EBITDA number because they can get away with it. EBITDA is not an official accounting term under regulation (compared to say ‘net profit’ or ‘net earnings’), so companies will try to mask bad results using ‘adjusted EBITDA’. If it was such a good quarter or financial year, why do they need to adjust it?
- Like analysts, investment bankers use EBITDA because it excludes things. For example, if you run an American company and you plan to buy a British company, would you need to worry about how much interest or taxes that company pays? The answer is you wouldn’t because after you own it, you’ll probably pay taxes in America, not Britain. Therefore, most bankers describe acquisitions using EBITDA because it provides a better picture of the company after they buy it. For example, a banker would say, “the value of the deal is worth 5 times the company’s EBITDA”.
How is EBITDA calculated?
Take a look at this income statement (we made it up):
| This year ($m) | Next Year ($m) | |
| Revenue | 100 | 120 |
| (Cost of sales) | – 20 | – 20 |
| Gross profit | 80 | 100 |
| (Expenses) | – 10 | – 10 |
| EBIT | 70 | 90 |
| (Interest cost) | – 10 | – 15 |
| EBT | 60 | 75 |
| (Taxes – 10%) | – 6 | – 7.5 |
| Earnings/Profit | 54 | 67.5 |
Where’s EBITDA?
EBITDA is not found on the Income Statement, but EBIT is ($70m this year). So we have one thing we need.
What’s the missing part of the puzzle?
Yep, that’s correct! DA, or Depreciation & Amortisation.
The amount for Depreciation and Amortisation comes from another part of the annual report, the ‘Cash Flow Statement’ (if you’re in the United States) or the ‘Notes to Financial Statements’ (if you’re in Australia or overseas).
If you’re looking at the notes, you’ll usually find a small table like this:
Reconciliation of Profit to Cash Flow
| This year ($m) | Next Year ($m) | |
| Adjustments to Cash Flows | ||
| Depreciation & Amortisation | 20 | 22.5 |
(hint: try doing a search with the terms “reconciliation”, “depreciation” or “adjustments”)
EBIT + DA
| This year ($m) | Next Year ($m) | |
| EBIT (Income Statement) |
70 | 90 |
| Depreciation & Amortisation (Cash Flow Statement or in the Notes) |
20 | 22.5 |
| EBITDA | 90 | 112.5 |
Using our example company, it has EBITDA of $90m this year and $112.5m next year.
You can repeat this process for any company or share you plan to research.
What’s the difference between EBITDA and Gross Profit?
Gross profit is simply revenue minus cost of sales. Both of these are found on a company’s Income Statement.
Sometimes, you’ll have to calculate EBITDA yourself using the Income Statement and the Cash Flow Statement, or Notes.
Should I trust EBITDA?
The world’s greatest investor, Warren Buffett, wrote to shareholders during the Global Financial Crisis, “Beware geeks bearing formulas”.
If you plan to invest, be critical of analyst projections and CEO presentations, especially when they use terms that aren’t regulated by accounting standards (like EBITDA).
Instead, focus on terms like Free Cash Flow, Operating Cash Flow or Net Profit after Taxes.
What the heck are ‘adjusted EBITDA’ and ‘underlying EBITDA’?
Whenever you read ‘adjusted’ or ‘underlying’ it usually means the company’s management or analysts have excluded some things. Sometimes these are okay, but often they are used to avoid presenting bad news to shareholders. Compare their ‘adjusted’ figure to what is written in official audited financial statements and make up your own mind.
EBITDA in ratios
Like all financial terms, EBITDA is often used in ratios like EV/EBITDA (enterprise value to EBITDA). Ratios like this can be used to compare the value of one company to another.
For example, an EV/EBITDA ratio of 5 means the ‘value of the entire company’ is 5 times the EBITDA.
Over on www.raskfinance.com, we cover EBITDA and heaps of other valuation ideas in our free valuation course.
LEARN MORE – HOW TO PICK 3 PROVEN GROWTH + DIVIDEND SHARES
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