To determine a particular stock is making profits or not, EBITDA and EBITDA margins are key factors investors watch, but how do these affect profitability, what is the link between them? I’ll explain it clear.
What is EBITDA?
To measure how much profit company is making from its core business EBITDA is used.
EBITDA stands for Earnings before Interest, Taxes, Depreciation & Amortization.
Means how much a company is making profit before paying any Interest to borrowers, before paying government taxes, before any Depreciation and Amortization.
- INTEREST: Paying Interest on borrowed money.
- TAXES: Paying Government related taxes.
- DEPRECIATION: Loss in value of tangible an asset.( example. if a company buys a machine worth 1lakh, after 1year asset value decreases due to usage and time value.
- AMORTIZATION: Non-cash expenses on non-tangible like patent rights, Licenses, software rights.
How it is Calculated?
EBITDA is calculated by adding
EBITDA= Net profit+ Interest+ Taxes+ Depreciation+ Amortization
or
EBITDA= Operating Revenue−Operating Expenses (excluding Depreciation & Amortization)
Example: 100(net profit)+20(Interest)+10(taxes)+10(Depreciation)+10(Amortization)= 150 is EBITDA.
What is EBITDA Margin?
To determine profitability in percentage, from total sales (revenue), EBITDA Margin is used.
For example: If Revenue is 1000, ebitda is 20 then ebitda margin will be,
EBITDA Margin= REVENUE/EBITDA, 100/20=5. so ebitda margin is 5%.
But even EBITDA is high EBITDA margin can be low sometimes, because if Revenue rises faster than EBITDA, this can cause operating expenses to increase rapidly due to jump in revenue.
To know how much profit company is making from its core business EBITDA is used, in the same way to know profitability in percentage terms EBITDA Margin is used.
—Disclaimer: The information provided in this article is for educational and informational purposes only.