Finance and Management - 35

In the earlier blog, we completed looking at the various heads in the PnL account. Today we try to understand a popular measure in the IT industry that is used to measure profitability - EBITDA.

We know from the earlier blog that EBIT stands for "Earnings before Interest and Taxes"; that aspect of EBITDA remains same, we add to the list both depreciation and amortization. This is found to be a very convenient tool to measure the profitability of firm across companies as well as across industries. To calculate EBITDA, one takes the net income and adds to that the interest, tax, depreciation and amortization aspects back to it.

There are both arguments for and against the use of EBITDA.

The people not favoring the use of EBITDA argue that:

1. Factoring the I, T, D and A as part of the measure can make even an unprofitable firm look fiscally healthy.
2. It is easy to manipulate - fraudulent accounting practices can really make a company more attractive than it really is

EBITDA finds favor amongst people since:

1. Can be used as a shortcut to estimate the cash flow that could fund the long term debts
2. Can also be used to compare companies against each other and against industry averages
3. Is a good measure of core profit trends because it eliminates some of the extraneous factors and allows a more equal comparison

2 very interesting metrics have been defined using EBITDA are:

Measure of Debt's payback period = Debt/EBITDA

Interest coverage ratio = EBITDA /Interest Expense

Read in Kannada:
http://somanagement.blogspot.com/2011/10/blog-post.html