EBITDA: Its relevance

Ever wonder why a lot of times analysts or even executives of companies quoted EBITDA to provide measurement on a company. Some of them may even say, things like this, "From next year onwards, we will have positive EBITDA." What does that represent? Is EBITDA really that important and significant?

If I want to think negatively, companies that quoted EBITDA basically are telling us they are not making that much profit or any, hence the term EBITDA rather than Net Profit. I am actually not entirely correct in this remark, but sometimes this is true.

What is EBITDA actually? In simple terms, we just have to take the Net Profit - add back the "ITD & A" which represents Interest, Taxes, Depreciation and Amortisation. "ITDA" are all supposed to be non cashflow items, except for "I and T". Lets look at each and every one:

Interests - Costs of business or financing. If the Interests are high, it means that the business is on high financing. If the interests are low, then the "I" in EBITDA is not that relevant. If interests is the costs of financing, then the company still has to pay them off. In some cases, why the "I" is mentioned is that the company is trying to raise equity funding which does not have a hurdle rate (interest). By including the "I", they are basically telling the potential investors that the investment will have reduced the "I" element. Hence, in this case EBITDA is relevant.

Tax - Higher Profit, higher taxes. Hence, this is the least important alphabet in the EBITDA equation. I rather look at EBIDA. Taxes is a cashflow item, unless they are deferred taxes. Taxes are taxes, and the company has to pay means it has to pay.

Depreciation and amortisation - Now, these are the more important elements in the EBITDA. Where do the depreciation and amortisation come from? Investments. In most cases, unlike cashflow, companies do not take a charge on the expenses immediately. They depreciated them. As a result, companies or executives, incurred the massive investments normally would want to look at Earnings Before Depreciation and Amortisation. This is because, subsequent to the investments where the D & A are significant, it is time to look at what the company makes. Hence, EBITDA.

Now, when is EBITDA not important? If they are saying the EBITDA is way better than the Net Profit, however future investments in the business is still substantial, then EBITDA is not the right measurement. Let me give an example - if Green Packet says the EBITDA is improving but the Net Profit does not seem to be so, and if the company is still investing into 4G(LTE) - then where is the relevance in EBITDA? If say, IGB REIT (which for example only has one mall, and they are not reinvesting after the completion of the mall), then the company would be good for EBITDA calculation. This is because the D & A affects the Net Profit while the free cashflow is actually higher.

Remember, EBITDA is not free cashflow though.

I would be showing a relevant example through looking at EBITDA as comparison in my next article.

For an almost similar type of article, please read, 
Maxis vs Digi: Numbers your friendly analysts don't tell you