EBITDA calculation is very important before we take any decision regarding buying shares in a company. This article will help you to understand its calculation in a systematic way. Have a look.
EBITDA margins, or the Earnings Before Interest, Taxes, Depreciation and Amortization margins, refer to the income generated by a company before it makes the expenses of taxes, interests on debt, and before depreciation is cut from its income. Calculation of these margins is given special importance these days by corporates as well as investment analysts. The calculation requires information about the business transactions of a company in a particular period. Let us understand the meaning of EBITDA margins and their importance, in the next section.
Why are EBITDA Margins of a Company Important
The EBITDA calculation refers to how strong the core business of a company is, and how its subsidiaries are performing in different sectors. Calculating it can be extremely useful to determine how strong the orders are that the company has from its clients, and how fast revenue is received by it. This is also a measure of whether the expansion plans of a company are working and whether the management is running it in the right way. If the calculation reveals that the EBITDA figures are high, then it indicates the operational efficiency of a company. By calculating the margins, we can predict the future profits earned by that company. This calculation is vital for leveraged companies or for those ones which have large debt in their books.
However, what we must remember is that calculating EBITDA is not the only way of forecasting the profits of a company. Practically speaking, these margins are not the net profit of a company, and according to some financial analysts, these numbers can be misleading. Many of them therefore consider only the net profit of companies while rating them and assigning stock price targets. So apart from EBITDA calculation, you also need to concentrate on the other fundamentals of firms, before you buy any stocks of those firms.
Not all companies manage to have a high EBITDA. A company may have impressive sales, but due to many other negating factors like high cost of advertising, or poor cost-cutting measures, or even high input costs, etc., its overall profit margins may take a pounding. This also happens if a company is in the process of reconstruction, cut-throat competition where prices are falling rapidly, or if the company is relatively new and trying to stand firmly in the market that it has entered. Leaving all factors aside, if a company has a trend of showing impressive profits and posting good EBITDA margins, then one can conclude that it is doing well and will rise above all adverse effects and competition. Companies that usually generate high margins are related to the banking sector, finance sector, engineering sector, and pharmaceutical sector. This is why most investors feel it is safe to buy the stocks of such companies.
Calculating EBITDA Margins
Calculating EBITDA margins is simple, and it requires you to be thorough with basic accounting and finance principles. What you need is the financial details of the company for a specific period of time, and a calculator. The first step would be to find the net income of the company. This can easily be done by subtracting the total expenses from the total income. Refer to the formula given below.
Net Income = Total income – Total expenses.
The next step is to find out the total taxes on income paid to government and income tax authorities. Then you calculate the interest paid to people for using their capital for business, and then finally, you find the cost of depreciation and cost of amortization. Now, the EBITDA can be calculated by having a sum of all these factors and then subtracting the same from the total expenses.
EBITDA = Operating Revenues – Operating Expenses (excluding interest expenses, taxes, depreciation, and amortization) + Other Revenue Generated.
Apart from this method of EBITDA calculation, you can also use the formula given below to compute this figure.
EBITDA = Interest + Net Income + Taxes + Depreciation + Amortization.
Here is an example depicting EBITDA Calculation, as a reference to make understanding it easier.
|Income / Expense
|Amount / Total
|(+) Other Income and Interest on Deposits
|(-) Cost of Sold Goods
|(-) Operation Expenses
|(-) Depreciation of Furniture, Fixtures and Equipment
|EBIT / Net Income
|(-) Income Tax
|Net Income (for the year)
|(+) Income Tax
|(-) Other Income and Interest on Deposits
(figures are purely for illustration purposes)
This article will now help you find this figure accurately, and conduct a good research on the stock market and some specific stocks too. So follow these methods and get a better idea of the investments that you are planning to make.