EBITDA (earns before interest, tax, depreciation and amortization), is basically a measure of profitability before the incidence of interest and taxes. It is obtained by adding depreciation and amortization to operating income (EBIT). It is widely used by advisors, managers and investment banks, as a measure of a company's operating performance, for analysis of financial statements, credit analysis and valuation. However, there are some disadvantages to this indicator. Looking at EBITDA in isolation can give a less accurate idea of a company's actual results.
In the chart below we show that from 2008 to 2017 Apple's EBITDA grew 707.08%, from $8,760 million to $70,700 in 2017.
Apple EBTIDA
Now that we understand what EBITDA is we can demonstrate the methods of calculations:
Fórmula I
In order to understand the above formula we demonstrate below the terms used:
EBIT Earn Before Interest and Taxes Operating: It is essentially the result obtained from the company's operations. Also known as EBIT (Earns Before Interest and Tax). This concept gives the fair idea of a company's ability to generate profits. It disconsiders any gains or losses arising from operations from the sale of assets and financial results. For example, a company can have positive operating results, lose on its financial results, and lose loss on asset sales.
Depreciation: Depreciation is basically the cost of a company's assets allocated over its useful life. This includes tangible assets such as machinery and equipment, buildings, furniture and utensils, computer equipment, vehicles etc. Part depreciation can be allocated as expense and the other part as cost of products, all depend on the structure of a company's assets and where they are allocated.
Ex.: A company purchased a packaging machine for R$ 8,000,000 and the depreciation period of this equipment will be 10 years or 120 months, so the monthly depreciation calculation will be R$ 8,000,000/120 = R$ $100,000 monthly.
Amortization: It differs from depreciation only in that it is an allocation of the costs of a company's intangible assets over their useful life. These intangible assets may include the rights to exploit public services through concession or permission from the Government, trademarks and patents, acquired copyrights, software and goodwill. Suppose that a certain intangible asset cost BRL 6,000,000 and that the amortization period is 5 years, so we can calculate the amortization as follows: BRL 6,000,000/60 = BRL 100,000 monthly.
Fórmula II
Where do we use EBITDA??
EBITDA is used for a variety of analytical purposes, however the main justification for its application stems from the notion that EBITDA provides a measure of a company's gross operating earnings, which excludes asset write-down expenses, financing costs and tax expenses.
Other uses of EBITDA:
EBITDA provides a measure of earnings that is not distorted by differences in accounting treatments such as depreciation and amortization, effects of financial leverage, taxes and various tax treatments, therefore, it is an indicator that allows a comparable analysis of national and international companies;
EBITDA can provide a starting point in calculating free cash flow;
EBITDA provides an indication of the debt potential that a business can support, through liquidity measures such as EBITDA/INTEREST and DEBT/EBITDA;
EBITDA is a key indicator in company valuations, in particular, through the EV(Enterprise Value)/EBITDA indicator and in the calculation of DCF (Discounted Cash Flow).
Cautions when using EBITDA in economic and financial analysis
Despite being an important and widely used indicator, we must be careful when using EBITDA in economic and financial analyses, as it has several limitations when analyzed in isolation, including:
EBITDA is only a proxy for Operating Cash Flow and is not an accurate measure of cash flow in any form;
EBITDA is an accounting measure of earnings that is susceptible to manipulation by company management;
EBITDA can be over- or under-estimated using the equity method;
EBITDA can be a misleading measure of liquidity.
EBITDA can be impacted by the choice of leasing method (eg, financing versus operating leases);
EBITDA does not incorporate working capital requirements;
EBITDA does not incorporate Capex requirements;
EBITDA does not provide an adequate measure of earnings for companies that operate with assets with a short life cycle, or that are potentially subject to new investments due to changes in the structure/technology of the sector in which they operate.
EBITDA is not necessarily consistent on a global basis, given the different treatments of corporate combinations, revenue recognition and expense recognition by accounting standards in various countries;
EBITDA is not relevant to the banking and insurance business as its earnings are largely supported by interest income;
EBITDA does not consider the amount of reinvestment required especially for companies with short-lived assets;
EBITDA says nothing about earnings quality;
Despite being widely used, the EBITDA multiple is not an adequate measure in company purchase and sales processes, since each company is unique, regardless of belonging to the same sector of another company;
EBITDA ignores distinctions in cash flow quality resulting from different policies. Not all income is money;
EBITDA is not suitable for analyzing many industries because it ignores their unique attributes.
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Luis Valini
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