EBITDA

EBITDA, Earnings before interest, taxes, depreciation and amortisation is a measure of a company’s overall financial performance and is used as an alternative to simple earnings or net income in some circumstances. Earnings before interest, taxes, depreciation and amortisation, however, can be misleading because it strips out the cost of capital investments like property, plant, and equipment.

This metric also excludes expenses associated with debt by adding back interest expense and taxes to earnings. Nonetheless, it is a more precise measure of corporate performance since it is able to show earnings before the influence of accounting and financial deductions. EBITDA EBITDA EBITDA EBITDA EBITDA

Simply put, Earnings before interest, taxes, depreciation and amortisation is a measure of profitability. While there is no legal requirement for companies to disclose their EBITDA, according to the U.S. generally accepted accounting principles (US GAAP) or International Financial Reporting Standards (IFRS), it can be worked out and reported using information found in a company’s financial statements.

The earnings, tax, and interest figures are found on the income statement, while the depreciation and amortisation figures are normally found in the notes to operating profit or on the cash flow statement. The usual shortcut to calculate EBITDA is to start with operating profit, also called earnings before interest and tax (EBIT) and then add back depreciation and amortisation.

https://www.merriam-webster.com/dictionary/EBITDA

EBITDA first came into common use with leveraged buyouts in the 1980s, when it was used to indicate the ability of a company to service debt. As time passed, it became popular in industries with expensive assets that had to be written down over long periods of time. Earnings before interest, taxes, depreciation and amortisation is now commonly quoted by many companies, especially in the tech sector – even when it isn’t warranted.

A common misconception is that Earnings before interest, taxes, depreciation and amortisation represents cash earnings. Earnings before interest, taxes, depreciation and amortisation is a good metric to evaluate profitability, but not cash flow. Earnings before interest, taxes, depreciation and amortisation also leaves out the cash required to fund working capital and the replacement of old equipment, which can be significant.

Consequently, Earnings before interest, taxes, depreciation and amortisation is often used as an accounting gimmick to dress up a company’s earnings. When using this metric, it’s key that investors also focus on other performance measures to make sure the company is not trying to hide something with Earnings before interest, taxes, depreciation and amortisation.

The EBITDA Multiple, representing ratios used when the entity has determined that market participants would use such multiples when pricing the investments, are also used as unobservable inputs in IFRS 13 Fair value measurement (market comparable companies). Such EBITDA multiples may range between 10 – 13 times EBITDA (Healthcare industry) and 6.5 – 12 times EBITDA (Energy industry) for continued operations and 3 – 5 times terminal EBITDA for terminal values.

Selecting comparable company valuation multiples
An investor is measuring the fair value of its non-controlling equity interest in Entity H, a private company. Entity H is a car manufacturer. The investor has selected five comparable public company peers: Entities B1, B2, B3, B4 and B5. These entities have the same risk, growth and cash flow-generating potential profiles as Entity H. They also operate in the same market (luxury
passenger cars) and are at a similar stage of development as Entity H.The investor concludes that EBIT or EBITDA are both relevant performance measures for Entity H. For this reason, and also to remove any distortion in the valuation multiples that the differences in capital structure between Entity H and its comparable public company peers might cause, the investor has decided to consider both EV/EBIT and EV/EBITDA multiples as potential relevant valuation multiples to measure the fair value of Entity H.Entity H and its comparable public company peers have similar asset bases. When comparing Entity H with Entities B1–B5, the investor observes that Entities B1 and B2 have depreciation policies (ie useful life estimates for the depreciation of their tangible assets) that are similar to that of Entity H.

However, Entities B3–B5 have a very different depreciation policy that uses a much longer useful life for the depreciation of their tangible assets than Entity H does, resulting in a lower depreciation expense. Entity B4’s depreciation policy is in between Entity H’s and Entities B3 and B5.

The EV/EBIT and EV/EBITDA multiples are as follows:

The investor observes that the range of the EV/EBITDA multiples is narrower (5.9x–6.9x) than the range of EV/EBIT multiples (6.3x–10.0x).

While the average and median EV/EBIT multiples are very close, the differences in the depreciation policy between Entity H and Entities B3–B5 does not make them comparable at an EBIT level and, consequently, neither the average nor the median EV/EBIT multiples are relevant in valuing Entity H.

The average and median EV/EBITDA multiples are also very close. In this example, the investor selects the EV/EBITDA multiple because it considers that all five entities are comparable to Entity H at EBITDA level. The differences in depreciation policy do not affect the EV/EBITDA multiple, because the earnings used in this multiple have not been reduced by any depreciation expenses. Consequently, the investor concludes that the EV/EBITDA multiple is the most relevant multiple to measure the fair value of Entity H.

The multiples were prepared using information from Entities B1–B5’s financial statements at the end of the reporting period, which coincides with the measurement date. The investor confirmed that the accounting policies of the remaining underlying assets of the comparable public company peers and of Entity H were the same. No additional adjustments to the valuation
multiples were deemed to be necessary.

In determining where within the range to select the multiple, the investor observes that the average and median multiples are very close. The investor selects an EV/EBITDA valuation multiple of 6.7x because it believes that Entity H has characteristics (for example, risk, growth and cash flow-generating potential profiles) that are similar to the comparable public company peers at the upper end of the range of valuation multiples.

EBITDA

EBITDA

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