EBITDA for dummies… not that you are one…

EBITDA is one of the biggest abbreviations I have come across in my life. It is equalled in abbreviated length by our own Government’s JNNURM.
 
EBITDA stands for Earning before Interest,Tax, Depriciation and Amortization. All of them are big words whose meaning needs to be explained except for Income tax which everyone is painfully aware of.
Instead of explaining each term by copying and pasting from wiki, I thought I will explain with an example. ex: – Taxi business
  
Suppose I buy a car, say Tata Nano and run it as a taxi. I would have to put in some money say 2 lac for the car. Over a period of 1 year, I run it successfully( without  catching fire) and get quite a few customers. My figures would be something like this –
  • Taxi fares earned – 2 lacs
  • Petrol cost – 50,000
  • Maintenance cost – 10,000

Now, my EBITDA would be 2 lacs – 50,000 – 10,000 = 1.4lacs

However, this 1.4lac figure is not actual profit for me because I have not considered ITDA.

Lets consider each one and take that into account. Since I bought a 2 lac car, I would have taken a bank loan for say 1 lac. This would have EMI payments. Lets consider it to be 1000 per month or 12000 in a year 

So I=  -12000

The D stands for Depreciation. It is a way of measuring the loss of value of an asset you posses. So, in our example, my asset is my beloved Nano. However, after 1 year, if I sell it, I might get, maybe, 1 lac for it. I paid 2 lacs for it. SO my depreciation would be 1 lac.

D = – 1 lac

The A stands for Amortization. it is similar to Depreciation but for intangible assets. In my example owning the brand new nano was an intangible asset. All my customers were eager to try it out and check out the interior space etc. So, when I asked for double fare especially from people coming out of grand buildings like UB city, they never complained and paid up. However, over the next few years nano would become more common place, the novelty factor wears out and people would not be willing to pay me double fare. So, next year I might not make 2lac in fares. I might make only 1.9lacs. so my amortization is 10,000

A = -10,000  

Now, we can calculate the tax as follows –

Taxable income = 1.4 lacs – 12,000(I) – 1 lac(D) – 10,000 (A) = 12,000

IT  = 30% of 12,000 = 3,600.

So, my net income or profit for the year when I drove a nano taxi is 8,400 rupees. 

As you can clearly see the difference between EBITDA and net profit is huge.  Hence, US has specified that all companies that are listed on stock exchange should use GAAP ( generally accepted accounting principles) which means declaring net profit/loss along with EBITDA.

EBITDA margin is the EBITDA divided by total revenue as percentage. So, for my taxi business EBITDA margin is 1.4lac/2lac * 100 = 70%!!

For a much simpler and non-accurate example you can consider the salary that you saw in your offer letter as your EBITDA. The net salary that you get in your bank account is the net profit…rest just vanishes :-)

If you are still wondering what JNNURM stands for – it is Jawaharlal Nehru National Urban Renewal Mission.

2 Comments

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2 Responses to EBITDA for dummies… not that you are one…

  1. harry

    Fantastic explanation of EBITDA – thank you so much!

  2. DANIEL E RATTI

    Thank you. Loved the example.

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