EBITDA: Full Form, Meaning, Formula, Calculation, & Importance in Business

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EBITDA is a metric often used in finance. It stands for (E - Earnings, B - before, I - Interest, T - taxes, D - Depreciation, and A - Amortisation). Companies use this method to measure profitability in net income. While applying for a Business Loan, it is important to know the EBITDA meaning. Let us understand what is EBITDA through this article.

What Is EBITDA?

EBITDA stands for Earnings before Interest, Tax, Depreciation, and Amortisation. It is a metric used to provide insights into a company's profitability. EBITDA's full form in finance excludes non-cash expenses, making it another variation of EBIT. It analyses whether the company can generate income from its core business activities. While doing so, it excludes the impact of financing costs, tax obligations and non-cash expenses like depreciation and amortisation.

Investors, analysts and businesses use EBITDA calculations to compare profitability and evaluate the performance of any company.

Why is EBITDA Important?

EBITDA holds a great value in the business for various reasons. Let's study why EBITDA is important:

EBITDA calculation excludes non-operational factors like interest and taxes and non-cash expenses like depreciation and amortisation. Excluding these elements can help provide a clearer view of the company's core profitability.
It provides a comparative analysis among businesses in different tax brackets, industries or capital structures. It helps investors and analysts to assess the performance of any company.
It helps in evaluating any company's ability to cover interest expenses. It is an important factor for banks like Kotak Mahindra Bank to gauge the company's creditworthiness to provide a Business Loan.

How is EBITDA Calculated?

The EBITDA calculation is easy. The EBITDA formula is:

EBITDA = Net Income + Interest + Taxes + Depreciation + Amortisation

For a simpler explanation, let's go through the example:

Let's assume a company has:

Net income: Rs 5,00,000

Interest: Rs 50,000

Taxes: Rs 1,00,000

Depreciation: Rs 30,000

Amortisation: Rs 10,000

Let's plug these values into the formula and find out what is EBITDA of the company:

EBITDA = 5,00,000 + 50,000 + 1,00,000 + 30,000 + 10,000

= Rs 6,90,000

In this case, the EBITDA of a company is Rs 6,90,000.

What are the uses of EBITDA?

Now that we know what does EBITDA mean and why EBITDA is important, let us go through the uses of EBITDA:

Assessment of Profitability:

EBITDA is used to assess a company's profitability. It provides a clear understanding of the company's financial health.

Comparative analysis:

It provides a simple and clear analysis of companies from different industries, tax brackets and capital structures.

Debt evaluation:

At Kotak Mahindra Bank, we use EBITDA to assess whether the company can cover interest payments for the business loan.

Valuation:

EBITDA is used by investors and analysts to determine a company's valuation.

EBITDA as a Financial Metric

EBITDA stands for being an important financial metric for several reasons.

It highlights the company's core profitability by excluding tax, interest and non-cash factors.
It does not consider capital investment like plant, property or equipment.
It emphasises more on companies' operating decisions and excludes considering expenses related to debt.

Due to these reasons, some may not consider it an accurate measure of profitability. It might also hide the lack of quality in financial judgments.

Nevertheless, EBITDA is an important financial metric most companies use. It provides a precise idea of the earnings before deductions.

What is the EBITDA Margin & Valuation

EBITDA margin and valuation play an important role in financial analysis.

What is EBITDA Margin?

EBITDA Margin represents the percentage of the company's EBITDA concerning its total revenue. It analyses how effectively a company makes a profit from its operations.

EBITDA Valuatio

EBITDA is a fundamental component often used to determine a company's worth or valuation. It simplifies the valuation process.

The formula for EBITDA Margin is:

EBITDA Margin = EBITDA / Aggregate Revenue

For example, if a company’s revenue is Rs 50,00,000 and its EBITDA is ascertained to be Rs 5,00,000, then as per the formula

EBITDA Margin = 5,00,000 / 50,00,000 = 10%.

Also Read: RBI Circular Guidelines on Current Account

Advantages and Disadvantages of EBITDA

EBITDA comes with many advantages and disadvantages.

Advantages	Disadvantages
EBITDA offers a clear view of a company's profitability and helps in assessing operational performances.	It excludes costs like interest, tax, depreciation and amortisation, which are essential for a comprehensive financial picture.
It aids investors and analysts in cross-industry and cross-company comparisons.	It does not consider a company's ability to meet debt obligations. This information is crucial for investors and banks to lend Business Loans.
It helps management make strategic decisions and identify areas of improvement.	It creates confusion since it is not a Generally Accepted Accounting Principle (GAAP) metric.

EBITDA Coverage Ratio

The EBITDA coverage ratio is a crucial metric often used to gauge a company's financial strength. It determines whether the company's pre-tax income can cover all interest-related expenses like lease payments.

The EBITDA coverage ratio formula is expressed as:

EBITDA Coverage Ratio = (EBITDA + Lease Payments) / (Interest Payments + Principal Payments + Lease Payments).

If the value comes equal to greater than 1, it indicates the company's financial stability and ability to meet its financial obligations.

Also Read: Cancelled Cheque: How to Write it