Understand what EBITDA means and how it works!
When it comes to investing in companies, we know that buying stocks can lead to superior performance compared to more conservative securities. However, this type of investment also carries greater risk. Therefore, it’s crucial to thoroughly understand the companies you’re investing in to determine whether they offer growth potential .
There are several indicators that can be used in this assessment, and one of them is EBITDA. In this article, you’ll understand what EBITDA means, its importance, why it’s used, and how it should be calculated. Read on to learn more!
What does EBITDA mean?
EBITDA is an acronym for Earnings before interest, taxes, depreciation, and amortization. depreciation, and amortization . These are two names for the same indicator. Therefore, some articles and news stories may use EBITDA, while others prefer Profits before interest.
Thus, we understand that EBITDA is a financial indicator widely used to evaluate companies before deciding whether to invest in them. It measures a company’s ability to profit from its core activities, excluding taxes, fees, depreciation, amortization, and return on investments. This allows a company’s gross profits to be monitored.
What is the importance of this concept?
EBITDA is a complex concept to understand, but its function is clear: to assess whether a company can profit from its core business. For example, a supermarket’s EBITDA assesses whether it can profit from sales of its products to the public, outperforming its competitors.
This indicator is widely used in the evaluation of publicly traded companies on the stock exchange. It also assesses an organization’s cash generation potential , discounting external factors such as rising interest rates. This allows investors to assess which companies are most efficient in their activities within their segment.
Why is EBITDA used?
EBITDA is used in a specific but very important context. Some companies are heavily indebted, but that doesn’t mean they’re not efficient. Therefore, debt burdens can obscure the potential for future profitability for these organizations once their finances are in order. Thus, potential investors can make their decisions based on the company’s efficiency, without taking current debt into account.
Furthermore, there’s another very important use for investors: comparing the profit potential of companies from different countries. Because different countries have different tax rules, EBITDA, by not taking these aspects into account, facilitates a fair comparison . A company may be more profitable simply because its home country has lower taxes, for example. Therefore, it’s important to make a more objective assessment.
How should EBITDA be calculated?
The first step is to calculate your net operating profit—net revenue minus operating expenses and costs of goods. You can also calculate your organization’s EBITDA by adding your net profit, income tax, social security contributions, net financial result, amortization, and depreciation .
This way, we arrive at the most used formula for calculating EBITDA:
If the available statements do not show the net operating profit, it will be necessary to calculate it according to the following formula:
Now that you know what EBITDA means, it’s easier to understand that it’s one of an organization’s financial indicators, widely used by investors to assess cash generation potential. However, this indicator doesn’t take into account interest, taxes, depreciation, and amortization, and should only be used in contexts where these variables can be disregarded.
