EBITDA (Earnings Before Interest, Taxes, Depreciation and Amortisation)

 

Why Investors Like EBITDA in Valuation

See, whenever people start talking about valuing a company, EBITDA almost always comes up. It’s not some magic number, but it does make things a bit easier to understand.

Basically, EBITDA tells you how much the company is earning from its actual business. It leaves out things like interest on loans, taxes, and some accounting stuff, which can sometimes make profits look confusing.

Now imagine you’re comparing two companies. One has taken a lot of loans, the other hasn’t. One pays more tax, the other less. If you look at their final profit, it won’t really be a fair comparison, right? That’s where EBITDA helps — it kind of removes these differences and gives a more level view.

It also gives you a rough feel of how the business is doing in terms of cash from operations. Not perfect, but enough to get an idea.

And in real life, especially in deals like mergers or acquisitions, people often rely on EV/EBITDA. You’ll see it being used again and again.

At the end of the day, investors like it because it shows how the core business is performing, without too many distractions. It’s not the whole picture, but it’s a good starting point.

There is also a slight decrease in EBITDA. This did not consider capital expenditure and working capital requirement. So, a smart investor should always analyze it along with metrics like Net Profit and Free Cash Flow.

How to say EBITDA in simple words will help you cut through complex numbers and show the real earnings power of the business.

Let’s understand about EBITDA more

What’s is EBITDA

EBITDA shows the profit earned from core business operations before considering the impact of financing costs, taxes, and accounting adjustments.

This shows a clear picture of a company's actual operating performance by removing items that may differ across companies.

Investors prefer EBITDA because it makes it easier to compare companies. If they have different debt levels or tax structures.

It is commonly used in valuation methods like the EV/EBITDA multiple.

EBITDA provides a quick estimate of operating cash flow before taking capital expenditure into account.

Private equity and venture capital investors use EBITDA to evaluate a company’s efficiency and its potential to generate returns.

EBITDA stands for Earnings Before Interest, Taxes, Depreciation and Amortisation.

Formula:

EBITDA = Net Income + Interest + Taxes + Depreciation + Amortisation

Why do investors use EBITDA?

Because it focuses on the profit earned from the operating performance of a business by excluding interest taxes and all non-cash expenses like depreciation amortization. It makes it easier to compare companies across different industries and countries.

Mergers and acquisitions are most commonly used to calculate fair valuations for companies.

Because it provides a simple and quick estimate of operating cash flow.

It is not affected by the capital structure. The debt or equity mix has no impact on the outcome.

It helps investors quickly understand the profitability and efficiency of a business.

Valuation Metric – EV/EBITDA

It shows how much you are paying for a company compared to its operating profit. EV/EBITDA means Enterprise Value divided by EBITDA. It is a generally used valuation multiple.

EV - If you want to buy the whole company, EV is the total cost, including both debt and equity, after adjusting for cash. EV = Market Cap + Debt – Cash

EBITDA is the company’s profit from core business operations without the impact of financing cost (Interest) and taxes.

·        Low EV/EBITDA ratio means company is undervalued as compare to other

·        High EV/EBITDA ratio means company is overvalued as compare to others or that investors expect strong future growth.

·        This metric is widely used for Mergers and acquisitions and investment decisions by investors and analysts.

Example – Two Companies

Let’s take two companies to understand this better.

Company A has taken a lot of loans. Because of this, it pays high interest every year, which reduces its final profit (net income).

But if you look closely, its EBITDA is quite strong, which means the main business is actually doing well and generating good operating profit.

On the other hand, Company B has very little debt. Since it doesn’t have to pay much interest, its net income looks higher on paper.

However, its EBITDA is lower, which shows that its core business is not as strong as it appears.

So, if you only look at net income, Company B may seem better.

But when you look at EBITDA, you realise that Company A is actually performing better at the operational level. This is why investors prefer EBITDA — it helps them focus on the real business performance and makes comparison fair by removing the impact of debt and taxes.

Advantages of EBITDA

Shows real business performance - EBITDA emphases only on the core operations of the company.

Makes company comparison easy - Different companies have different debt levels and tax rates. EBITDA removes these differences, so it becomes easier to compare companies fairly, even if they are in different countries or industries.

Ignores non-cash expenses - Expenses like depreciation and amortisation are accounting entries, not real cash outflows. EBITDA don’t consider them, so you get a better idea of the company’s cash-generating ability.

Useful for investors and analysts - Investors use EBITDA to understand whether a company is operationally strong or weak.

It is important to calculate multiple EV/EBITDA for valuation

Better for companies with high debt - Companies with heavy loans may show low net profit due to interest costs. EBITDA helps in seeing their true operating strength, ignoring debt impact.

It is helpful in estimating future cash flows from operations.

Limitations of EBITDA

EBITDA does not include interest expenses. So, a company with huge debt may look strong in EBITDA, but in reality, it may be struggling to pay interest.

Taxes are a real expense, but EBITDA removes them. This can make a company look more profitable than it actually is.

Many people think EBITDA = cash, but that’s not true. It does not consider working capital changes (like receivables, inventory), so actual cash may be very different. 

Businesses need to spend money on machines, buildings, maintenance, etc. EBITDA ignores these costs, which can overstate profitability, especially in capital-heavy industries (like manufacturing, telecom).

If you only look at EBITDA, you might miss important risks like: High debt, poor Cash flow, Heavy future expenses

Companies can highlight EBITDA to make performance look better, even when net profit is weak.

Conclusion

EBITDA helps in understanding the core operating performance of a business.

It removes the impact of interest, taxes, and accounting adjustments, making analysis simpler.

It is very useful for comparing companies, especially with different debt levels.

Investors widely use it in valuation tools like EV/EBITDA.

However, EBITDA is not actual cash flow and ignores important costs like interest and capital expenditure.

So, it should always be used along with other financial metrics, not alone.

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Capital expenditure (Capex) vs Revenue Expenditure (RevEx)

What is the difference between Capital Expenditure and Revenue Expenditure.

First of all, we understand capital expenditure in detail in a very simple way.

Capital expenditure (Capex)– All companies, whether small, medium, or large, incur expenses to support their growth. However, not all expenses are treated the same in accounting. Accounting depends on the type of expense incurred. Some expenses help businesses increase earnings in the long term, while others do so in the short term.

In other words, capital expenditure is a large, one-time expenditure incurred to purchase, upgrade, or maintain property, plant, or equipment. These assets can be either physical or intangible such as patents. that will benefit the business for long period.

These expenditures are recorded as asset and depreciate every year till life of the asset.

Example of Capex: Purchase of machinery

Purchase land or building

Purchase of vehicle for business

Major reconstruction of office

Why these expense companies do.

Actually, companies do capital expenditure to generate revenue or enhance productivity for the future, not just to meet immediate operational needs.

In simple words: CapEx is money spent to grow the business capacity.

Accounting treatment of Capital expenditure

When a company purchases machinery worth Rs. 120000, it is booked as an asset in the balance sheet, this is called capitalizing the asset. It is not fully charged as an expense in the year when it is purchased, instead depreciation is charged every year. This means the entire cost of the asset is divided over its useful life and booked year wise as a depreciation expense in the P&L.

Example:

If machinery life is 10 years → ₹10000 depreciation per year (assuming straight-line method). This means profit is reduced gradually, not immediately.

 

Revenue Expenditure (RevEx)- Revenue expenditure is routine ongoing expenses which are incurred for day-to-day business operation and maintaining assets. These are normal operating costs like salaries, wages, rent, utilities, supplies and regular maintenance. These expenses are necessary for short‑term operational needs and here we do not create new assets.

These expense gives short term benefits to the business, they do not increase the earning capacity but they are important to maintain earning capacity. These expenditures are Repeated and regular.

In simple words: RevEx is money spent to run the business regularly.

Accounting treatment of Revenue expenditure

Rev expenditure is booked immediately in the income statement as an expense whenever it is spent in any period. by booking these expenses we reduce our net income.

Examples: Paying employee salaries, utility bills, routine repairs, office supplies, or advertising costs.

Examples of Revenue Expenditure
•             Salaries and wages
•             Rent
•             Electricity bills
•             Advertising
•             Repair and maintenance
•             Office supplies

Why is This Difference Important between Capex and RevEx:  Many business owners are confused about how to classify expenses and why it is necessary to classify.

1.            For Profit Calculation

If capital expenditure is mistakenly recorded as revenue expenditure, the current year's profit will be reduced significantly, even though the asset is meant for long term use. As we discussed, if a large amount is invested in capex, then the current year profit of the business will be less if large expenses are recorded in the income statement.

If revenue expenditure is wrongly treated as capital:

Profit will appear higher. Because by not showing revenue expenditure expenses in P&L, we have shown long term assets in the balance sheet so financial statements become misleading.

2. For Tax Impact

Revenue expenses reduce taxable income immediately. Capital expenses are depreciated over time, so tax benefit is spread across years.

Proper classification helps in correct tax planning.

3. Investment Decisions: - When an investor comes to invest in your company, investors analyse:

How much capex has the company incurred and how much revenue expenditure has it spent on operations.

High capex may indicate business expansion.

Special example: Major Repair

If company spends ₹3,00,000 and the machine’s life increases by 5 years, then it may be treated as Capital Expenditure, because it increases future benefit.

Capital Expenditure vs Revenue Expenditure in Financial Statements 

Capital Expenditure Appears In:

•             Balance Sheet (as asset)

•             Depreciation shown in Profit & Loss Account

Revenue Expenditure Appears In:

•             Profit & Loss Account only

•             Reduces net profit directly

Common Mistakes

•             Recording major renovations as regular expenses even when they extend the useful life of an asset.

•             Capitalizing minor day-to-day costs that should actually be treated as operating expenses.

•             Failing to calculate and record depreciation accurately, leading to incorrect profit reporting.

•             Blurring the line between personal and business transactions, which creates confusion in financial records. Proper accounting knowledge prevents financial errors.

How to Identify the Difference Quickly

To determine whether an expense is capital or revenue in nature, ask yourself these two simple questions:

1. Will this expense provide benefits to the business beyond one financial year?

•             If yes, it is likely a Capital Expenditure.

•             If no, it is generally a Revenue Expenditure.

2. Does this expense enhance the earning capacity of the business, or does it simply maintain current operations?

•             If it enhances or expands earning potential, it should be treated as Capital Expenditure.

•             If it only supports or maintains existing operations, it is a Revenue Expenditure.

Using this quick evaluation method can help you classify expenses accurately and maintain reliable financial records.

Conclusion

Knowing the difference between Capital Expenditure and Revenue Expenditure is very important for managing money properly in a business.

Capital Expenditure helps a business grow.

Revenue Expenditure helps a business run every day.

Both are important.

Without investing in assets, a business cannot expand.

Without daily expenses, a business cannot operate.

•             For students, this topic is important for exams.

•             For business owners, it helps in better financial planning.

•             For investors, it helps in understanding how a company is performing.

When you clearly understand this difference, reading financial statements becomes easier, and you can make better business decisions.

For any query regarding the post or if you want to learn any topic you can write me on

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IFRS - 16 Leases

 

What is lease – Lease is a Contract between owner of the asset and the other party who want to take that asset on rent for use.

What is difference between rent and lease

Simply you can understand that rent is a short-term deal (6-month, 11 Month) and lease is a long term (3 Years, 5 years, 10 years) deal between owner and tenant.

There are two parties In Lease transaction

Lessee – who takes the asset on lease and pays rent payments.

lessor – Who gives the asset on lease and receive rent payments

Example – Company ABC takes a care on lease from XYZ Car Leasing Ltd.

Company ABC – Lessee (ABC will use the asset and pay the rent)

XYZ Car leasing Ltd – Lessor (Owner of the asset, earn rent).

Now we will understand the lease agreement by the example of Rent. But remember if it is short term then it will be rent agreement and if it is for long term agreement then it will be lease.

What happened in Rent agreement one person takes a property on rent he/she pays the rent and use the asset, so he get the right of use but not the ownership of the asset.

Now how to identify it is lease transaction or not

IFRS 16 – Definition of Lease (IFRS16 Para 9)

A lease exists when a contract gives below to customer

1.    The right to control the use of …

2.    An identifies asset …

3.    For a period of time …

4.    In exchange of consideration (Payment)

*** Even a owner adds some protective clauses in the contract, it does not mean that the lessee lost the control.

Accounting process for Lessee

Initial measurement – when you enter in a lease agreement you will get a asset but not owner so we will write it as a Right to use. We will do Debit right to use instead of asset. And we will credit Lease Liability.

Journal Entry

Right to use A/C              Dr.     45000

To Lease Liability            Cr.      40000 (Present Value of all future payments)

To Cash                           Cr.     5000 (Initial Payment)

At the initial stage of lease, the lessee recognises a right to use asset and a lease liability.

Right of Use asset	Lease liability
Measure at the amount of the lease liability plus any initial direct cost incurred by the lessee.	Measured at the present value of lease payments payable over the lease term, discounted at the rate implicit in the lease
Lease Liability          Initial direct cost          Estimated cost for dismantlement         Payments less incentives before commencement date	Fixed payments less incentives Variable payment (E.q CPI/ Rate Consumer per index) Expected residual value guarantee Penalty for terminating (if reasonably Certain) Note: - if the rate implicit in the lease can not be determined. The lessee shall use their incremental borrowing rate.

Subsequent measurement

Right of Use asset	Lease liability
Cost less accumulated depreciation Note:  Depreciation is based on the earlier of the useful life & lease term, unless ownership transfers in which case use of the useful life.	Financial Liability at amortised cost

 

Asset – Depreciation (Asset life – 10 years, lease – 6 years) which ever is shorter

Lease liability – Opening Lease liability + interest (-) payment = closing balance 

Optional Recognition Exemptions

IFRS 16 normally requires lessees to recognise ROU asset & liabilities. But for simplicity, 2 exemptions allowed:

Type	Conditions	Example
Short term	Lease less then or equal 12 month & no purchase option.	Renting a printer for 6 months
Low value	Asset value is low when new (around $5000 or less )	Tables, laptops, office furniture

Why IFRS 16 Was Introduced

Before IFRS 16, companies used to keep many leases off the balance sheet. That made financial statements look stronger than reality.

For example, airlines lease aircraft worth billions, but earlier those obligations were not visible on balance sheets.

Now: Assets increase, Liabilities increase, EBITDA increases, Interest expense increases, Debt ratios change

This gives a more realistic picture of financial position.

Optional Recognition Exemptions

IFRS 16 provides two practical exemptions for lessees:

1. Short-Term Lease

If lease term is 12 months or less and there is no purchase option, companies can expense payments directly.

Example: Renting a printer for 6 months.

2. Low-Value Asset

If the asset value is low when new (around $5,000 or less), recognition of ROU and liability is not required.

Examples: Laptops, Office furniture, Small equipment

These can be treated as normal expense.

Financial Statement Impact

Lease accounting affects:

• Balance Sheet
• Increase in assets (ROU)
• Increase in liabilities (Lease Liability)
• Profit & Loss
• Depreciation expense
• Interest expense

Earlier, lease payments were fully shown as operating expense. Now expense pattern changes.

Practical Understanding

From a business perspective, leasing helps companies:

• Preserve cash
• Avoid large upfront investment
• Use updated assets
• Maintain flexibility
• From an accounting perspective, IFRS 16 ensures:
• Transparency
• Better comparability
• Accurate debt representation

Final Thoughts

Lease accounting may look technical, but the logic is simple:

If you are using an asset for a long time and committing to future payments, that commitment should appear in your financial statements.

You may not own the asset legally, but economically you are controlling it.

That’s why IFRS 16 recognises:

•       Right of Use Asset
•       Lease Liability

Understanding lease accounting is important not only for exams but also for analysing companies properly. Many businesses today depend heavily on leased assets.

When you read financial statements next time, check:

How much lease liability is there?

What is the lease term?

How does it impact cash flow and profit?

Because sometimes, the biggest obligations are hidden in plain sight.

And finance is all about understanding those hidden commitments clearly.

 For any query regarding the post or if you want to learn any topic you can write me on

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IFRS9 – Financial Instrument

Definition 1 - Financial Instrument or Asset is any asset that is Cash, any Equity instrument (e.g., Shares) of another company & a contractual right to receive Cash.

Definition 2 - It covers a contract between two parties which gives to one party financial asset & to other party financial liability & Equity. The simple words, financial asset means right to receive Cash.  

Definition 3 - In Simplest Language – In IFRS9 you Show financial assets at today’s market value, and decide whether the gain goes to profit or a separate place (OCI), based on why you bought the asset.

What type of assets are covered in IFRS 9?

1.     Shares                         -           Buying Tata / Apple shares

2.     Bonds / Debentures    -           Giving loan to a company

3.     FD / Loan given          -           Bank FD or money lent to someone

4.     Mutual Funds              -           Equity or debt MF

5.     Derivatives                  -           Gold future, dollar contract

Note - Land, building, car, inventory is not covered here 

Now Understand what is fair value in very simple manner

Fair Value means today’s market price. Forget about the purchase price, how much you paid. Only ask “If you sell it today, how much money will you get?”

Example - You bought a share at ₹2,000

Today’s market price = ₹2,300

Fair Value = ₹2,300

Now the question comes where to show this ₹300 Gain or loss (if any). Then you have to identify. Why did you buy this asset? Based on your answer, the profit goes to different places.

Case 1: You bought shares to make quick profit. With a though of “Price will go up. I will sell and earn”.

Example: Buy share at ₹1,500. Year-end price = ₹1,800. Gain = ₹300

This ₹300 is shown directly as profit

This is called - Fair Value through Profit & Loss (FVTPL)

Case 2: You bought shares as long-term investment. With a though of “I will keep it for many years”.

Example - Buy share at ₹1,000, Year-end value = ₹1,200. Gain = ₹200

This ₹200 is not treated as normal profit. As you have not booked it yet. It is shown in a separate box, not in profit. This separate box is called OCI (Other Comprehensive Income).

This method is called:

Fair Value through OCI (FVTOCI)

Case 3: Now understand FD / Loans / Bonds

Example: You give ₹1,00,000 to a bank or company. You expect Fixed interest every year & Full money back at the end. Here no daily buying or selling. no market guessing. So, in this case IFRS 9 says “Do NOT change its value daily”. You just show interest income & keep the original amount

SPPI Test - SPPI only asks ONE simple question:

Will you receive only my money + interest?

If you will get Simple interest type return SPPI Test pass. But if you will get Market-linked return then SPPI test is fail.

SPPI – Pass >>> Examples: Bank FD, Simple loan Fixed-interest bond

SPPI – failed >>> Examples: Return depends on share price, Return depends on gold or dollar price

How do you get Fair Value - Real market numbers

Level 1 – Direct market price for Listed shares and Mutual fund NAV >>> Stock exchange price

Level 2 – You have to do Market comparison for Unlisted bond from Similar interest rate data >>>RBI rates, bank yields

Level 3 – in Case of Startup investments Estimated value for Private company shares >>> Expected future profits (best estimate)

What you bought	Why you bought	Value based on	Shown where
Shares (trading)	Quick profit	Market price	Profit
Shares (long term)	Investment	Market price	Separate box (OCI)
FD / Loan	Interest	Original amount	Interest income
Derivatives	Speculation	Market price	Profit

Okay now we are going to connect the real word accounting with what we have learnt. Here we are going to learn about Two Financial Assets.

Investment in Equity instrument – IFRS9

Method	When Applicable
1. Fair Value through P&L	Default option for all Equity Investments
2. Fair Value through OCI	Irrevocable Election at initial recognition (non trading Only) Simple – If management decided the URGL of particular equity will go to OCI. Then 2 conditions need to Follow 1.      The decision will be irrevocable for URGL transfer to OCI 2.      If the Equity will be sold in future, then realised gain or loss will not transfer to P&L. it will go to Retained earnings

Fair Value through P&L (FVTPL)

·       Default classification

·       Mandatory for equity Instruments held for Trading

·       Also used when entity does not make OCI election

·       Example – investing in shares of listed company for short term gain (Intraday or swing trading)  

Fair Value Through OCI (FVTOCI)

·       Only for equity instruments not held for trading.

·       Requires an irrevocable election at the time of initial recognition.

·       Suitable when investment is made for strategic reasons or long-term holding.

·       Example: Investment in shares of a business partner company for long-term strategic interest. 

Important Point

·       Equity shares do not have fixed or contractual payments like principal and interest.

·       Returns (like dividends or capital appreciation) are not predictable or contractual.

·       There's no maturity or repayment obligation in shares.

·       Conclusion: Equity investments cannot be measured at amortised cost under IFRS9 -

they must be measured at fair value (either through P&L or OCI).

Accounting for Equity Investments- Comparison (FVTPL vs FVTOCI)

 

Aspect	Fair Value Through P&L (FVTPL)	Fair Value Through OCI (FVTOCI)
Initial Measurement	At fair value + Transaction costs →P&L (expensed)	At fair value+ Transaction costs → Capitalised
Subsequent Measurement	Fair value changes -> P&L (gain/loss)	Fair value changes → OCI (gain/loss)
Dividend income	Goes to P&L if it represents return on investment	Goes to P&L if it represents return on investment

 

Accounting for Investment in Debt instrument – IFRS9
Debt instrument (e.g. Bonds, Debentures Can be classified under three Measurement Categories)
1.     Fair Value through P&L (FVTPL)
2.     Fair Value through OCI (FVTOCI) 

3.     Amortisation Cost  

  For accounting of investment in debt instrument you have to check two test

1. BMT – Business Model test – Whether the business model is to hold the asset to collect the contractual Cash flows  

2.     CCFT (SPPI)– Contractual cash flow test – are the Cash flow from the asset solely payments of principal and Interest (SPPI) if you are going to received Interest and principal amount at maturity

Three Accounting methods for financial Asset Debt instruments

1.     If BMT & CCFT both test Pass then show at amortisation cost means ignore fair Value (Held to collect cash flows)
2.     If BMT fails and CCFT test Pass then show as FVTOCI (Held to Collect + Sell)
3.     Fails CCFT or Default Category will go in FVTPL (Trading / Complex Instruments)

For any query regarding the post or if you want to learn any topic you can write me on

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