Welcome to the "Finance Storyteller" series.
I am here to make business strategy and finance
enjoyable and easier to understand.
In this video we are going to cover
the financial terms EBIT and EBITDA.
Let me give you some context,
so you know where EBIT and EBITDA fit in.
There are three financial statements:
The balance sheet,
an overview what we own
and what we owe at a point in time.
The income statement,
an overview of the profit or income
that you generate during a period.
And...
The cash flow statement, an overview of
how much cash you generate, and where you spend
your cash during a period.
EBIT and EBITDA are income statement metrics.
EBIT is Earnings Before Interest and Taxes.
EBITDA is Earnings Before Interest, Taxes,
Depreciation and Amortization.
Earnings is the same as income or profit.
The word "before" suggests that we are excluding
certain items from our operational performance
metric.
Interest is excluded,
as it depends on your financing structure.
How much did you borrow,
and at what interest rate?
Taxes are excluded,
because it depends on the geographies
that you work in.
Depreciation and amortization are sometimes excluded,
because they depend on the historical
investment decisions that a company has made,
not the current operating performance.
Let me show you an overview of an income statement,
or profit and loss statement, so you know
where EBITDA and EBIT fit in.
Revenue minus Cost Of Sales equals Gross Profit.
Gross Profit minus S,G&A and R&D equals EBITDA.
EBITDA minus Depreciation & Amortization equals EBIT.
EBIT minus Interest and Taxes equals Net Income.
Please be aware that different companies
use different terminology,
so what you see here
might be different from what your company is using.
Also, not every company reports both on EBITDA
as well as EBIT.
EBITDA is commonly used as a metric
in very capital-intensive industries
like manufacturing,
trucking, oil and gas, and telecom.
Service-heavy industries like consultancy
wouldn't even bother splitting out the two.
What is depreciation?
How does that work?
Let's assume you want to buy a truck for your company
to deliver your products.
You spend $100,000 to buy it.
What happens on your financial statements
is that cash goes down by $100,000, and your
fixed assets (or "plant and equipment")
go up by $100,000.
It would be incorrect to book the full $100,000
straight away as a cost for the current year,
because you are going to use the truck
for multiple years.
That's when depreciation comes up.
Let's assume that the truck has a useful economic life
of 5 years, and has no residual value.
If you use straight-line depreciation,
you book $20,000 per year in depreciation.
The value of the asset on the balance sheet
goes down by $20,000 per year, and in the
income statement you charge
this $20,000 as an expense.
Let's look at an example of using EBIT and EBITDA
in financial reporting.
I took the 2015 annual report of the Maersk Group,
a company headquartered in Denmark
and operating globally.
They report in US$.
Their best known business is Maersk Line,
which is the world's largest container shipping
company.
They are also active in areas like
oil and gas,
terminals and drilling.
Maersk's revenue in 2015 was 15% lower
than the year before, and net income (or net profit)
was down by 82%.
But is net income the most relevant way
to measure their profitability performance?
Maersk gives you the choice
to also evaluate profitability
at other levels: EBIT was down 68%,
and EBITDA was down 24%.
Depreciation and amortization
are sometimes referred to as "fixed costs",
they don't go
up and down with the number of units that you sell,
but they are driven by the investments
that you have made,
and the number of years you use those assets.
In the case of a company like Maersk,
which operates in a capital intensive industry,
depreciation is a huge number, 8 billion USD in 2015,
almost 20% of revenue.
Looking at the EBITDA
as well as the EBIT performance
gives you more information than
looking at EBIT alone.
What do business and finance people use EBITDA for?
It is often mentioned as part of M&A
(or Mergers & Acquisitions) news.
A quick-and-dirty way
to calculate the value of a company
is by using a multiple of EBITDA.
This can help you to get to a ballpark number,
but I would advise to always do a more thorough
analysis and a more thorough valuation of a company,
as there are a lot of "ifs" connected
to using an EBITDA multiple:
you are assuming the profitability
and the industry does not
change, you exclude the impact of working capital
(which could go up dramatically for
a fast-growing company), and you exclude
the cash that you need for capital expenditures
on an ongoing basis for the company.
In summary: what is EBIT and EBITDA?
EBIT is Earnings Before Interest and Taxes.
EBITDA is Earnings Before Interest, Taxes,
Depreciation and Amortization.
Both EBIT and EBITDA are measures of profitability,
along with terms like gross profit and net income.
EBITDA is a meaningful metric
for capital-intensive industries.
I hope you have enjoyed this "Finance Storyteller" video!
Thank you for watching!
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