Wealth Vidya - Learn Wealth Creation through Value Investing: 10/02/16

EBDITA stands for ‘Earnings Before Depreciation, Interest, Tax and Appropriations’.

Meaning:

Profits of a company are measured at various stages or levels to draw certain meaningful conclusions about the operational efficiency and comparative standing of a company vis-à-vis its peers, and EBDITA is the first level. It measures the earnings or profits after cost of raw materials and all expenses other than the following:

Depreciation
Interest
Corporate Income Tax
After Tax Appropriations or set-asides like towards reserves, dividends, etc.

What is the significance of the EBDITA Measure?

If we want to compare the efficiency of operations of a few peers operating in the same business space or segment, and if we adopt a simple comparison of profits after tax, we may be both incorrect as well as doing injustice as the companies may have cost structures not directly related to their operational efficiencies.

Example:

For example one plant may be an old one involving a low depreciation charge over its already highly depreciated plant while the other one is brand-new plant installed recently at a heavy cost and therefore attracting a heavy depreciation charge. Similarly, one company might have setup its plant entirely from own funds and hence bears zero interest costs while the other may have employed borrowed funds and therefore paying significant interest costs. Under such circumstances simply comparing the companies based on ultimate net profit, may lead to erroneous conclusions and hence the need and significance of measure of EBDITA.

	M/s.Old & Conservative Ltd.	M/s.New & Extravagant Ltd.
Sales	1500.00	1520.00
All Costs & Expenses before Depreciation, Interest, Tax and Appropriations	800.00	810.00
EBDITA	700.00	710.00
EBDITA % to Sales	46.67%	46.71%
Depreciation	30.00	100.00
Earnings after Depreciation but Before Interest, Tax and Appropriations (EBITA)	670.00	610.00
EBITA % to Sales	44.67%	40.13%
Interest	0.10	70.00
Earnings after Depreciation and Interes but Before, Tax and Appropriations (EBTA or EBT)	669.90	540.00
EBT	44.66%	35.53%
Corporate Income Tax	221.07	178.20
Net Profit or Profit After Tax (PAT)	448.83	361.80
PAT %	29.92%	23.80%
Dividends	134.65	108.54
Net Profits After Taxes and Appropriations (PAT&A)	314.18	253.26
PAT&A % to Sales	20.95%	16.66%

From the above example it becomes evident that both the companies are having similar sales and core operational cost structures, with the EBDITA margins around 46%. However the Old & Conservative limited has an old, highly depreciated plant and hence incurs lower depreciation charge whereas the New & Extravagant Ltd., has a brand-new plant and a high depreciation cost. Similarly the former has no outstanding loans while the latter has borrowed funds to finance the venture. As a result while the former demonstrates robust net profit margin of 29.92% while the latter has only 23.80%. If the comparison had been made based on PAT margins one could have erroneously denounced the latter for operational inefficiencies, whereas in reality both have same core operational efficiencies, but the latter has a couple of unfavorable cost structures that are not directly linked to its core operational efficiency.