To measure the earnings of a company, EBITDA is one of the key metrics. It stands for earnings before interest, taxes, depreciation, and amortization. Using EBITDA as an indicator you can find out the real value of a business. EBITDA is significant for the company to evaluate its performance with previous years and competitors. Whereas, investors use EBITDA to determine the safety of their investments along with the dividend they may expect. The meaning of EBITDA is very important as investors make predictions about a company based on it.
What does EBITDA mean?
EBITDA or earnings before interest, taxes, depreciation and amortization is useful for computing the performance of the business by knowing the profits or losses a business is making. It provides lenders and investors with data about business performance in terms of its finances. It also provides an estimation of the operational viability of the business. Since EBITDA measures the financial performance of a company before external factors like taxes and interest, it is often used as an alternative to net income.
How to calculate EBITDA
There are two ways to calculate the EBITDA. They are;
· EBITDA = Net Profit + Taxes + Interest + Amortization + Deprecation
· EBITDA = Operating Income + Amortization + Depreciation
Significance of EBITDA
EBITDA is significant not only for the company but also for its stakeholders. Investors invest in a company or buy its shares only after considering the genuine performance of the company i.e. EBITDA. Through EBITDA the investors come to know about the operational performance and profitability of the company. When investors purchase shares after considering a rise in the EBITDA of a company, the prices of the shares move up. And when the performance or EBITDA falls the supply of shares increases in the stock market and its price falls. Similarly, EBITDA is important for lenders to understand whether they will be able to recover the amount lent or to know whether the money can be given as a loan to a company. EBITDA is used by a company to monitor its performance and compare it with its peers.
Advantages of EBITDA
The following are the advantages of EBITDA;
· Gives a reliable overview of the future growth of the business by giving a clear picture of the operating profitability.
· It gives an actual account of the expenses that a business requires for its regular functioning.
· It helps in comparison of a company with its competitors.
· EBITDA gives a clear view of the company’s cash flow generation during the ongoing business.
· The formula for EBITDA calculation is simple and can be easily derived.
The above mentioned are some of the benefits of EBITDA. The start-ups that require funds have many reasons to use EBITDA as their top indicator. It is a critical indicator for a company when it is used in good faith. It helps the company and its stakeholders to take wise decisions regarding the future direction. With EBITDA all parties are clear about the future performance of a company and comparison with the competitors can also be done easily. EBITDA is also useful for investing in stocks.