Here's Why EBITDA is a Winner

Updated: May 10

Pretty sure whenever you read about company financials, you come across a whole lot of weird acronyms (finance people like their acronyms like French people love their wine). It gets quite a lot trying to understand what they are telling you and why some seem to be more emphasized than others. Let's just say there are some that actually speak louder than others. And today I want to talk about one that screams; EBITDA. What is it and why is it always on the first paragraph of every financial report.

EBITDA stands for "Earnings before Interest, Tax, Depreciation and Amortization". Pretty long but it's also pretty simple. So let's take it back to what it means. The "Earnings" refers to net profit, the profit a company makes after all relevant deductions. It's sometimes referred to as the "bottom line" or "Net Profit After Tax". "Interest" is your interest on debt. "Depreciation" is the value that an asset loses over the cause of its lifetime. It's basically "wear-and-tear". And then we have "Amortization" which, in simple terms, is an expense spread out over some years instead of being charged all at once.

So what's the big deal about EBITDA? EBITDA is a proxy for cash generation. It tells us how much of operating cash the company is able to generate. How so?

  • By adding back non-cash expenses. If you want to see operating cash flow, depreciation and amortization (and impairment losses) will distort your perspective. These items have no real transaction - there's no "Money Out: R5 000 000" appearing anywhere. But Accounting standards do require us to record them in the Income Statement. Because they were subtracted to get Net Profit, you now add them back.

  • By adding back interest. Interest is added back because it's the cost of financing the company. To think of it simply, it's the cost of the money that helps you do what you need to do as a company? Think of the fact that companies borrow to help them buy inventory, equipment, expand, etc.

  • By adding back taxes. Taxes are more a legal obligation than an operational one. So you don't want that.

This makes EBITDA very wholesome and that is why it is given such high regard. Next time you come across an article or blog or financial report talking about EBITDA, don't be phased. You know what it is about now.

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Author: Nkanyiso Nyawose

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