Ebitda ratio

Ebitda ratio
See also

The Ebitda coverage ratio, also known as the debt sustainability ratio, is mainly used to assess the company's ability to cover interest associated with the company's debts[1].

According to Paulson E. "The Ebit/Ebitda ratio compares the total investment in a company to its basic income before financial or accounting policy- related expenses have been subtracted."[2].

This indicator, however, has two minor shortcomings[3]:

  • Due to the fact that many companies rent their assets and thus have to make lease payments, interest on debt is not the only financial burden to which the company is exposed. It must reduce its debt on schedule, so if your installments or lease payments are not paid, your company may go bankrupt.
  • The second disadvantage is the inability to represent all cash flows available for servicing the debt, especially if there are high depreciation charges. In order to take into account the above comments, the bankers presented the Ebitda coverage ratio as follows

\(Ebitda\,coverage\,ratio=\frac{Ebitda+Lease\,payments}{Interest+Principal\,payments+Lease\,payments}\)

The perspective of a lender

From the perspective of a lender with obligation notes, debt is treated as a kind of investment in a company. The creditor's funds will be used to generate income from operations. The company is expected to get a higher rate of return on the use of this money than the interest rate paid to the lender by the company[4].

By debt, we can define assets, i.e. money that the company incurred for its use, instead of paying the seller or lender. Reducing the amount of cash on debt provides the outstanding amount of net debt, as this money can be used to pay off the debt immediately. The total capital currently invested in the company is not the book value of equity, but the market value of shares. If it is transformed into another form of assets, such as cash, it represents the total value of the shares. Investors generally allow other investment opportunities because they retain their origin in the company at market prices[5].

Understanding Ebitda

The term Ebitda is an indicator used for companies that are not already in the early stages of development but do not yet achieve sufficient income to support themselves. This ratio is a modified form of the P / E ratio for enterprises that have no profits. In the case of such enterprises, attention should also be paid to the ratio of price to sales and burning of cash. Ebitda is a measure used by companies with gross profit but not net profit. Every mention of Ebitda indicates that the company is not yet profitable, but sees positive Ebitda as a milestone in development. As a ratio, Ebitda lies between gross profit and net profit. He continues to deduct business expenses such as rates, energy, insurance, and office workers. It does not include financial interest related to interest, depreciation. Tax, depreciation, and Ebitda are often overrated, especially by directors who promote positive Ebitda to cover up the net loss: positive Ebitda is like a person who claims to live within his means if he excludes mortgage, loan repayment, and income tax[6].

References

Footnotes

  1. Paulson E. (2000)
  2. Paulson E. (2000)
  3. OECD (2016)
  4. Paulson E. (2000)
  5. Paulson E. (2000)
  6. Leach R. (2010)

Author: Barbara Rojek