What is EBITDA
This denotes the company’s earnings before certain deductions like interest, taxes, depreciation and amortization. The expansion of EBITDA is earnings before interest, taxes, depreciation and amortization. This helps the investors to know what is the earning that the company makes before making the above deductions. This helps them investing money especially when the company is new, to find out whether it can sustain in the market after making these deductions.
If the numbers of EBITDA has a good growth rate some investors may use this gross rate rather the net margin. This helps the investors to understand that they rate of return on investments will also turn out to be good. The EBITDA also has some impending problems. It might leave out a lot of other expenses there by it may not show us the realistic profitability of the company. This might lead to not projecting the actual cash that is flowing into the organization.
Let’s see the factors that EBITDA neglects, the amount required for working capital, certain fixed expenses, pending debt payments, certain capital expenditures etc. Capital expenditure is a vital expense and an ongoing expense in any organization, if this is not taken into account by EBITDA the investors might land up with wrong figures when they calculate their return on investment.
Any business would not like to fiddle with its EBITDA; hence it is always better if the management can sit with its investors to understand what they are looking for. EBITDA does not come under the GAAP the company has to make its own adjustments when they calculate this amount. Usually for depreciation figures they may have to devalue their assets if it is very old to arrive at the proper figure. Likewise sometimes the organization might have failed to collect its receivables; this may result in negative cash flow that affects the EBITDA.
Hence EBITDA must not only be the only means to calculate the company’s value. As discussed earlier they must have to consider other metrics like capital expenditure, other monitory accruals. Here one has to understand that EBITDA has its own flaws, hence while making adjustment entries the accountant should be very careful not to make any major undervaluation if assets. Not only this the lenders also divide the interest on the money lent by EBITDA in order to determine the firm’s risk in paying them back.
The more cash is available with the company to pay off the interest the less risk the company will face. In case if the interest rates start rising this means the value tends to fall sharply. This in turn makes it very expensive to pay off the interest. Hence caution is the only mantra that the organization has to follow when it is calculating EBITDA.