What is EBITDA and Why is EDBITA Important to Organizations
What is EBITDA
EBITDA stands for Earnings Before Interest, Taxes, Depreciation, and Amortization and is a metric used to evaluate a company’s operating performance. It can be seen as a loose proxy for cash flow from the entire company’s operations.
Why is EBITDA important?
Why is it useful?
EBITDA is useful in considering the value of a company because it:
- Normalizes capital structure. EBITDA removes the impact of a company’s capital structure by adding back interest expense. The premise is that financing decisions shouldn’t affect the value of an enterprise because those financing decisions can be easily changed. When valuing a company, most buyers will assume that a company’s debt can be eliminated or refinanced as part of the transaction. Since a buyer can easily change the capital structure of the company, capital structure is ignored in determining value.
- Normalizes tax structure. EBITDA removes the impact of income taxes. The idea is that this makes firms easier to compare since two companies may have differing tax rates due to legal structure (e.g. C corporation tax payer vs. S corporation or limited liability company tax payer) or geography.
- Normalizes non-cash accounting decisions. EBITDA removes the impact of depreciation and amortization. These expenses are non-cash accounting constructs. The levels of a company’s depreciation and amortization are influenced by assumptions such as useful life and the value of intangible assets. These assumptions are not standard across all companies and are not indicative of a company’s ability to generate cash.
- Normalizes short-term fluctuations in working capital. EBITDA removes period-to-period fluctuations in net working capital. Unlike GAAP (generally accepted accounting principles), cash flow from operations from a company’s cash flow statement (which requires a reconciliation of period-to-period changes in balance sheet accounts like accounts receivable, inventory, accounts payable and accrued expenses), EBITDA theoretically illustrates the amount of cash flow a company generates from its operations on a sustainable, run-rate basis without potential noise from factors such as the timing of collecting accounts receivable or a build-up or reduction in inventory.
Source: https://www.montagepartners.com/insight/what-is-ebitda-and-why-its-important/
EBITDA vs Free Flow Cash Reporting:
Free cash flow (FCF) and earnings before interest, tax, depreciation, and amortization (EBITDA) are two different ways of looking at the earnings a business generates.
There has been some discussion regarding which method to use in analyzing a company. EBITDA sometimes serves as a better measure for the purposes of comparing the performance of different companies. Free cash flow is unencumbered and may better represent a company’s real valuation.
Key Takeaways
- Both free cash flow (FCF) and earnings before interest, tax, depreciation, and amortization (EBITDA) are methods for examining the earnings a business generates.
- Each method has its pros and cons as a measure, but EBITDA may be more useful when comparing the performance of different companies.
- FCF, on the other hand, may provide a better way to analyze a company’s performance on its own merits because it can provide insight into the level of earnings a firm has after meeting its interest, tax, and additional obligations.
Institutional and Private Investors want insight into the operations of an organization including ability to meet its operational expenses before interest, depreciation, and taxes. Organizations are constantly facing more pressure to maintain their margins in an era of high inflation, rise of geopolitical issues, cybersecurity threats, supply chain disruption, and changes in consumer spending behavior. EBITDA can provide good insight into operational areas of a business. It should be noted that EBITDA should be used with other calculations as part of assessing the overall financial health of an organization.
Additional links:
- Top profitable companies in the world — https://www.financecharts.com/screener/most-profitable
- High flying stocks — https://www.fool.ca/2024/04/06/3-high-flying-tsx-stocks-that-could-keep-on-climbing/
- Top US Stocks — https://www.morningstar.ca/ca/news/247195/6-top-performing-us-stocks-to-buy-now.aspx
- Stock Market — https://www.royceinvest.com/insights/small-cap-recap
- Quarterly — https://am.jpmorgan.com/ca/en/asset-management/institutional/insights/market-insights/market-updates/on-the-minds-of-investors/the-quarter-in-review-what-happened-in-the-first-three-months-of-2024/
- ESG / EBITDA — https://www.deloitte.com/be/en/services/financial-advisory/blogs/apr23-the-impact-of-esg-on-valuation.html
- Targeting the right programs to enhance EBITDA — https://www.cfo.com/news/private-equity-ebitda-finance/711906/
- EBITDA / Nasdaq — https://www.nasdaq.com/articles/pick-these-5-bargain-stocks-with-alluring-ev-to-ebitda-ratios-4
- Unlocking EBITDA value through the right generative AI strategy — https://insights.alixpartners.com/post/102ik6t/unlocking-real-ebitda-value-with-generative-ai
- Driving better data as part of enhancing EBITA targets through data modernization — https://www.technologyreview.com/2024/01/15/1086461/outperforming-competitors-as-a-data-driven-organization/
Paul Young CPA CGA is a former Senior IBM Customer Success Manager that has deployed over 300 data and AI solutions across geographies for the past 8 years. Paul is also FPA SME on how best to integrate macro and micro indicators as part of the data journey for the operational, management, and regulatory reporting cycles.
Blog — How to select the best ESG solution for your /Organization — https://www.linkedin.com/pulse/how-select-right-environmental-social-governance-solution-paul-young-83mzc/
Stock Market — https://medium.com/@paulyoung_81567/stock-market-analysis-for-the-week-ending-april-5-2024-72fcb937cbe8 or https://www.linkedin.com/posts/paul-young-055632b_stock-market-analysis-for-the-week-ending-activity-7182370500784926721-eb2m?utm_source=share&utm_medium=member_desktop