In our last post for investors, I had discussed EPS or earnings per share. You can read this post: What Is EPS? Earnings Per Share Importance For Investors. Now, the earnings season is approaching. In CNBC TV18 we every day listen to a specific term. EBITDA. Now, what is EBITDA full form? Why is EBITDA margin so important for someone willing to invest in a companies share.
EBITDA full form stands for Earnings Before Interest Taxes Depreciation & Amortization. It’s a different way for potential investors to evaluate a company that is it necessarily making profits OR not. EBITDA calculation became popular during the 1980s and during the dot-com bubble. It was often used by companies who were selling any sort of items over the internet. So it might be used by a new company that is spending more money than it is making for a certain period.
Generally speaking EARNINGS = TURN OVER – EXPENSES over a certain period. This is a single most important parameter to determine a stock’s price. Because its earnings which decide the future dividends and growth. But in EBITDA margin calculation we take into consideration expenses never happened. EBITDA is AN EARNING where it’s like a company has never paid interest OR taxes OR never depreciated OR amortization (lump sum debt allocation) happened. So basically EBITDA is an accounting gimmick.
To create EBITDA, start with operating profit and add back depreciation and add back amortization. Take a look at the example of this basic profit statement in the image below:
Here in the example we have taken the operating profit of 120, added depreciation of 25 and also added amortization of 20. So EBITDA margin comes to 120+25+20 = 165.
So though EBITDA is not a very safe method of calculation for an investor still it is utmost important in deciding the companies earnings at a glance.