EBITDA
Also written Earnings before interest, tax, depreciation and amortisation
Profit from running the business, measured before interest, tax, depreciation and amortisation — so before how the company is funded and how it accounts for its assets.
In plain language
EBITDA asks one question: is the actual business making money?
Take a company's profit and add back four things that have nothing to do with whether customers pay more than the business costs to run — interest (how it chose to borrow), tax (where it is registered and what reliefs it claims), and depreciation and amortisation (accounting entries spreading the cost of assets bought years ago).
What is left is the cash-like profit the operation itself throws off.
How it works
Two companies can run identical businesses and report very different net profit — one borrowed heavily to build its plant, the other raised equity. Interest cost makes the first look worse even though the shops sell the same goods at the same margin.
EBITDA strips that difference out, which is exactly why it is the standard comparison measure across companies in the same industry. It is also why it flatters a heavily indebted company: the interest it genuinely has to pay has been removed from view.
The formula
EBITDA = Profit after tax + Tax + Interest + Depreciation + Amortisation
Or working downwards instead:
EBITDA = Revenue − Operating expenses (excluding D&A)
A worked example
A mid-sized cement company reports, for the year:
| Line | Rs crore |
|---|---|
| Revenue | 4,200 |
| Operating expenses (excluding D&A) | 3,360 |
| EBITDA | 840 |
| Depreciation | 260 |
| Interest | 190 |
| Profit before tax | 390 |
| Tax at 25% | 98 |
| Profit after tax | 292 |
The EBITDA margin is 840 ÷ 4,200 = 20%, and the net margin is 292 ÷ 4,200 = 7%.
A competitor with no debt and older, fully depreciated plant might show the same 20% EBITDA margin but a 15% net margin. The operations are equally good; the balance sheets are not. EBITDA shows the first, and hides the second.
Why NISM asks about it
Chapter 8 (Company Analysis — Financial Analysis) uses EBITDA as the base for margin analysis, and Chapter 10 uses EV/EBITDA as a core relative-valuation multiple. Expect questions that hand you a P&L and ask you to work back up to EBITDA, and questions on why EV/EBITDA is preferred to P/E when comparing companies with different debt levels.
Common exam traps
- EBITDA is not cash flow. It ignores working capital movements and capital expenditure entirely. A company can grow EBITDA every year and still run out of cash.
- Depreciation is added back, not ignored. The plant really does wear out and really will need replacing. Charlie Munger's objection to EBITDA is precisely this.
- EBITDA sits above interest. So it is the wrong measure for judging whether a company can service its debt on its own — that is what the interest coverage ratio is for.
- Pair it with Enterprise Value, never with market capitalisation. EV includes debt; EBITDA is measured before debt costs. P/E pairs equity with equity; EV/EBITDA pairs whole-firm with whole-firm.
Check yourself
1.For 2XX9 a company reports (₹ lakh): profit before tax 2,929.6; depreciation and amortisation 218.6; finance cost 195.2. Which is closest to its operating profit?
- a)₹2,929.6 lakh
- b)₹3,124.8 lakh
- c)₹3,343.4 lakh
- d)₹3,945.5 lakh
Show the answer
Answer: (b) ₹3,124.8 lakh
The workbook states that EBIT is referred to as operating profit. To get from PBT back up to EBIT you add back the finance cost, which has already been deducted:
EBIT = 2,929.6 + 195.2 = ₹3,124.8 lakh
Why the others are there. ₹2,929.6 lakh is PBT itself — the answer for anyone who does not adjust at all. ₹3,343.4 lakh is EBITDA (2,929.6 + 195.2 + 218.6), and it is the single most tempting wrong answer because EBITDA feels like the operations number. It is one level above operating profit. ₹3,945.5 lakh is an arithmetic decoy.
Hold the waterfall in order: EBITDA → less D&A → EBIT (operating profit) → less finance cost → PBT → less tax → PAT.
2.Why can the P/E, EV/EBITDA and EV/EBIT multiples not be applied to certain companies?
- a)Because they only work for listed companies
- b)Because the multiple cannot be applied where the underlying profit metric is negative
- c)Because SEBI prohibits their use in published research
- d)Because they require at least ten years of financial history
Show the answer
Answer: (b) Because the multiple cannot be applied where the underlying profit metric is negative
These multiples divide a price or enterprise value by a profit metric — earnings, EBITDA or EBIT. They cannot be applied if the underlying profit metric is negative, because a negative denominator produces a figure that is not merely wrong but meaningless.
A related problem the workbook flags: where earnings are much lower than their long-term potential — a company just past a loss-making phase, or in a cyclical trough — the multiples would be too high to be meaningful even when technically positive.
The workbook's own answer for loss-makers is EV/Sales: it "is likely to be a more meaningful metric as sales can never be negative" (p209). Price to Book Value is the other multiple that survives a loss year. It focuses on how much an investor needs to invest to gain a claim on the assets, and the book value stays positive even when the current year's profit does not.
One further caution from the workbook: compare against the industry average and the median, since a single extreme comparable can distort the mean.
3.According to Warren Buffett as quoted in the workbook, what are the only two sources of value in a business?
- a)Growth and market share
- b)Earnings and assets
- c)Brand and management
- d)Revenue and market capitalisation
Show the answer
Answer: (b) Earnings and assets
"There are only two sources of value in a business — Earnings and Assets."
The logic runs through the whole chapter. Every asset generates periodic earnings and a final inflow on sale: a bond gives coupons and redemption, equity gives dividends and sale proceeds, real estate gives rent and an appreciated capital value.
Businesses are the same: they generate cash as earnings, with the potential to realise cash from the sale of tangible and intangible assets if the earnings die down and owners liquidate.
The other options name things that produce earnings or assets — brand, management, market share, revenue — but they are drivers, not sources of value in this framework. And the chapter's structure follows the split exactly: earnings-based valuation matrices (P/E, PEG, EV/EBITDA, dividend yield) and asset-based valuation matrices (P/B, EV to capital employed, NAV).
Where this is taught
Free preparation for NISM Series XVRelated terms
- Diluted EPSEarnings per share recalculated as if every instrument that can convert into equity had already converted — the pessimistic, and usually the more honest, share count.
- Enterprise ValueWhat it would cost to buy the whole business — market capitalisation plus debt, less cash — as opposed to market capitalisation, which buys only the equity.
- Free Cash Flow to EquityThe cash left for shareholders after operating costs, tax, capital expenditure, working capital needs and all payments to lenders — what could be paid out as dividend without harming the business.
- Return on EquityProfit after tax as a percentage of shareholders' net worth — what the company earned on the money its owners have left in it.
- Core working capitalInventory plus trade receivables minus trade payables — the money permanently trapped in the operating cycle, stripped of cash and borrowings, which have nothing to do with trading.
- Quick ratioCurrent assets excluding inventory, divided by current liabilities — a stricter liquidity test than the current ratio, because inventory cannot reliably be turned into cash in a hurry.
- Return on Capital EmployedOperating profit as a percentage of all the capital in the business, equity and debt together — the return the enterprise earns before any question of how it was funded or taxed.
- Free Cash Flow to FirmThe cash a business generates before any payment to any provider of capital — discounted at WACC it gives the value of the whole firm, from which debt and other claims are then subtracted.
- Sum-of-the-partsValuing a conglomerate by valuing each business separately on its own appropriate multiple and adding the results, instead of applying one blended multiple to the group.
- Management BuyoutA leveraged buyout in which the company's own management team borrows to buy a majority stake from existing shareholders and takes control of the business it already runs.
- Other Comprehensive IncomeGains and losses that Ind AS requires or permits to bypass the profit and loss account — they change shareholders' equity and never touch earnings per share.
- DuPont analysisBreaking return on equity into net profit margin × asset turnover × equity multiplier, to see whether ROE comes from profitability, efficiency or borrowing.
- Interest coverage ratioEBIT divided by interest expense — how many times operating profit covers the interest bill. Below 1, the business is not earning enough to pay its interest.
- Accrual basisThe accounting rule under which income is recorded when it is earned and expenses when they are incurred, regardless of when the cash actually moves.
- Adjusted profit after taxReported profit after tax with one-off, non-recurring items and their tax effect stripped out, so one year can be compared fairly with another.
- Capital work in progressProperty, plant and equipment that a company is still building or installing and that is not yet ready for use — held separately from PPE until completion.
- Consolidated financial statementA single set of financial statements combining a parent company with every subsidiary it controls, so a group's true scale of business is not hidden inside a stand-alone filing.
- Basis pointOne-hundredth of one percentage point — the standard unit analysts use to describe small, exact changes in margins, yields and interest rates without ambiguity.
- Operating Cash FlowCash actually generated by a business's core operations — profit after tax with non-cash charges added back and working capital movements adjusted, before any capital expenditure.
- Market approachValuing a business from what the market pays for comparable businesses, using earnings and market multiples rather than the company's own projected cash flows.
- Deal CompsRelative valuation using earnings based multiples — chiefly EV/EBITDA and EV/Sales — which the workbook also calls Transaction Comparables.
- Trailing earningsEarnings measured over the most recent period up to today, calculated on a rolling basis — most often as Trailing Twelve Months, distinct from historical or forward earnings.
- EBITEarnings before interest and taxes — the workbook's operating profit, struck one step below EBITDA after depreciation and amortisation, and the profit that has to cover the interest bill.
- Economic Value AddedA company's after-tax operating profit less a charge for the capital employed to earn it — the profit that remains after the providers of capital have been paid what they required.
- EV/EBITDAEnterprise value divided by EBITDA — a whole-firm valuation multiple that compares what it would cost to buy the business against the cash profit the business generates for all its funders.