Financial Ratios Part 11 of 21: The EBITDA Measurement of Profitability
What is the value of the Farm or Business’ earnings that can go towards debt repayment?
Financial Ratios & indicators can assist in determining the health of a business. There is a minimum of 21 different ratios and indicators that can be looked at by many financial institutions. You cannot look at a single ratio and determine the overall health of a business or farming operation. Multiple ratios and indicators must be used along with other information to determine the total and overall health of a farming operation and business. This series of articles will look at 21 commonly used ratios and indicators.
EBITDA is a measurement of Profitability and is determined based on information derived from a business’ or farm operations Income Statement. The term Profitability is the difference between the value of what is produced or service provided and the cost of producing that product or providing that service. The EBITDA is an acronym for Earning Before Interest, Taxes, Depreciation, and Amortization. This measurement specifically shows the amount of earning that are available for the repayment of debt.
The following equation will determine your EBITDA:
EBITDA = Net Income + Interest Expense + Depreciation and Amortization Expense
Amortization Expense is the expected expense of an intangible asset over its expected useful life or its legal life. This is similar to Depreciation but can be different. Depreciation usually will follow a legal equation provided by the IRS for most assets. While this may be a “legal” life in many cases, an asset may have a shorter or longer useful life than what has been determined by following an IRS depreciation equation. Such examples of an intangible asset may be the cost/value of a patent or license. Most farms and ranches do not utilize or work with intangible assets but the horticultural and nursery industry is seeing this grow through the development of new varieties of plants that are being patented.
EBITDA is measured in a dollar value. This value shows the earnings that are available that can go towards the repayment of debt.
If you have any further question please feel free to contact your local Farm Management Educator or the author.
Information for this article has been gathered using material created by the University of Minnesota Center for Farm Financial Management (CFFM).
You can read the other articles in this series:
Part 1: The current ratio
Part 2: Working capital.
Part 3: Working capital to gross revenues
Part 4: Debt-to-asset ratio
Part 5: Equity-to-asset ratio
Part 6: Debt-to-equity ratio
Part 7: Net farm income
Part 8: Rate of return on assets
Part 9: Rate of return
Part 10: Operating profit margin
Part 12: Operating profit margin
Part 13: Capital debt repayment margin
Part 14: Replacement margin
Part 15: Term debt coverage
Part 16: Replacement margin coverage ratio
Part 17: Asset turnover rate
Part 18: Operating-expense ratio
Part 19: Depreciation-expense ratio
Part 20: Interest-expense ratio
Part 21: Net income ratio