Stocky Lab 1: EBITDA vs Net Income

Lab Aug 30, 2020

Revenue

The total amount of income generated from the business.

Gross Profit

Gross profit is revenue minus the cost of goods sold. For Ex: If flipkart has a revenue of Rs 1 Crore and the actual cost of goods sold is Rs 80 Lakh; then the gross profit is Rs 20 Lakh.

What is EBITDA?

EBITDA means Earnings before Interest Expense, Tax, Depreciation & Amortization. When you remove Operational Expense which general administrative expense, salaries, research & development, etc. Let's break it down.

1. Interest Expense - This is the interest that needs to be paid for any borrowings/debt. This value does not include the principal amount of the debt, but only interest on it.


2. Tax - This is the corporate tax a company needs to pay on its earnings for the year to the government.


3. Depreciation - Companies that have assets like manufacturing plants, vehicles, machinery, etc when they are bought are considered assets in the balance sheet. But they are expensed over time. For Ex: If a company buys a truck for Rs.10,000 and will be using it for the next 10 years; the company will add Rs.1000 towards depreciation every year to spread out the expense.



4. Amortization - This is used to spread out the expense/cost of an intangible asset over a period of time. Intangible assets are like a trademark, patents, copyright, goodwill, etc. Let me explain with an example:    4.1 Amortization in Intangible Assets -  If you have a patent worth Rs.10,000 and its granted for 10 years; then you will be counting Rs.1000 every year towards amortization to balance it out.

Now, what is Net Income/Net Profit?

When you remove interest paid on the debt, income tax, depreciation & amortization from EBITDA; we get the net income for a company. It can be referred to as Net Income, Net Profit, Net Earnings, etc.
Now, we understand the definition of Net Income & EBITDA. Let's take a real-life example of UltraTech Cement.

UltraTech Cement Ltd (ULTRACEMCO)

We try to find the revenue & net income of ULTRACEMCO using moneycontrol for the last 5 years.
In the graphs below we notice that the revenue has been increasing year over year but the net income shows a sharp drop in the 2017-2018 year. You might wonder why would this happen, there could be a number of reasons here and how do we find it?


The first step or check is finding the EBITDA which can help us answer "Did the gross profit, EBITDA also go down or just the net income?"


In the graphs above, we see Gross profit and EBITDA both increased consistently. EBITDA gives us more of an objective earnings analysis where things like tax, interest, and depreciation don't come into the picture. But then we see that the interest expense increased by 96%(almost doubled) in 2017/2018 due to increasing debt.


The increasing interest expense would mean that ULTRACEMCO took a huge amount of debt in 2017 to expand and now we see a jump in interest expenses which did help the company to expand as suggested by increasing revenue but the bottom line(net profit) took a hit due to that.


Comparing EBITDA & Net Income is always useful while assessing a company as it lets you understand how much interest, tax and depreciation & amortization could swing earnings for a company.


Recap: We saw a company's revenue going up consistently, but not the net income. On deeper analysis with EBITDA, we found interest expense increased incredibly due to which the company net profit took a hit.

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Resources:

TheHinduBusiness

MoneyControl

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