Businesses are like us, and have worked for three bosses all our lives
We all know that most middle-class people have worked for three kinds of bosses for life: get up early every day, get white powder and get the salary of cabbage price-work for the boss; get the salary slip and find that every month must pay personal income tax ——Working for the government; the monthly salary must be saved, because the mortgage and interest must be paid at the end of the month ——Working for the bank. In fact, enterprises are the same.
In order to accurately measure corporate value from three different angles of creditors, government and shareholders, savvy accountants and investors invented EBIT, EBITDA and net profit. This series of articles is divided into three parts, and the key issues to be solved are: the true meaning of EBIT, EBITDA and net profit, and the connection and difference between the three. Under what circumstances should one or a combination of these three indicators be used?
EBIT (Earnings Before Interest and Tax)
EBITDA (Earnings Before Interest, Taxes, Depreciation and Amortization) profit before interest, tax, depreciation and amortization
Net Profit, Profit after tax Net profit, profit after tax
1. Who is the corporate income cake cut to?
Before discussing the three indicators of EBIT, EBITDA and net profit, let's take a look at how these benefits are distributed after the company makes a profit-to whom is the profit cake cut? In fact, each company's cake is eaten by three people:
Creditors-share loan interest
Government-Tax collection
Shareholders-share company dividends
When a company gains revenue, the first step is to generate "Operation Income" (Operation Income), which the company uses to pay creditors, such as bank loans, interest; then use the remaining profits to pay taxes to the government ; "Profit" (Net Income). Net profit (if preference shares are not taken into account) is the income that can be shared by shareholders who hold common shares in this company .
Therefore, these three destinations are the inevitable attribution of the profits earned by all enterprises.
The inevitable attribution here does not necessarily have to be paid. More precisely, not all three parties have to pay. Just as the profit statement deliberately arranges their payment order, the priority enjoyed by each party is different: the company ’s creditors are The highest priority, regardless of whether the enterprise makes money or not, the enterprise must pay the loan interest in accordance with the loan contract; only after the company makes a profit, the income tax is paid to the government.
If the enterprise loses money in that year, there is no need to pay income tax to the government; shareholders can only receive (cash) dividends if the net profit is positive, but shareholders can also decide not to share or only share (cash) dividends after mutual negotiation. All or part of the unshared net profit is invested in the enterprise (forming retained earnings) to continue to grow the enterprise. Of course, if the company's net profit loss was negative that year, shareholders would not get any piece of cake. In short, these three aspects are based on their seats to eat fruit (cake).
The three indicators of EBIT, EBITDA and net profit exactly match the three destinations of earnings.
Second, the true meaning of the three major indicators
EBIT pre-tax profit comes first
EBIT—Earnings before interest and taxes is the operating profit of an enterprise, which reflects the operating results of the company ’s core business .
The business results at this stage will not be affected by the company's "capital structure" (in short, how much of the company's capital source is dependent on debt, and how much is dependent on shareholders' investment and reinvestment. This capital structure determines how this EBIT cake Cut) and the impact of "taxation".
Therefore, EBIT is the total distribution source of the above three aspects-creditors, government and shareholders-and is a complete big cake. This is a significant difference between EBIT and the other two indicators.
Continue to analyze EBIT dismantling: it is derived from sales revenue minus cost of sales, operating costs, and depreciation and amortization of long-term assets (accounting will directly account for depreciation and amortization related to commodities in the cost of commodities). EBIT reflects the impact of cost and long-term capital expenditure (through depreciation) on corporate profits.
"Free cash flow" is the net operating cash flow minus long-term capital expenditures (Capex), which is similar to EBIT.
Next, talk about EBITDA
EBIT plus depreciation and amortization is EBITDA-profit before interest, taxes, depreciation and amortization, which can be regarded as a representative of the company's operating cash flow , rather than literally called "profit".
Like EBIT, this indicator reflects the company's net cash flow that is not affected by its capital structure and taxation.
If you are familiar with the cash flow statement under the indirect method (as shown in the following table, without considering other circumstances), it is easy to understand why EBITDA can represent the operating cash flow of the enterprise. Because the company's "operating cash flow" is adjusted by changes in net profit plus depreciation and amortization, plus or minus working capital, which is similar to the process of EBITDA plus EBITDA plus depreciation and amortization.
If you have never been exposed to accounting, Qinqin will use the figures in the above cash flow table as an example: If Qinqin Financial Consulting Company earned 1 million yuan in cash this year, the total cost will be 400,000 yuan (including depreciation of office equipment of 150,000 yuan) Without considering income tax, the net profit is 600,000 yuan. Did Qinqin get 600,000 yuan in cash by the end of the year? If not, is it more than 600,000 or less than 600,000?
Obviously, the cash received is 600,000 net profit plus 150,000 depreciation, a total of 750,000 yuan. The reason is simple. The depreciation of 150,000 in the cost is not paid in cash. This was already paid when the office equipment was purchased two years ago, so the net profit should be added back to 150,000, and 750,000 is the final cash.
Like EBIT, EBITDA is a complete big cake, which has not been distributed to creditors, governments and shareholders. Therefore, EBITDA belongs to creditors, government and shareholders. How do you cut this cake? The general rules of the game are still the priorities mentioned earlier-ranking the number of fruits and cakes, and then consider the capital structure of the enterprise and the tax system of the country.
EBIT and EBITDA are more convenient and intuitive than direct calculation of cash flow, so it can save time in predicting the company's future financial statements and performing corporate valuation. This is another reason why these two indicators are favored by investors.
The last thing to play is our well-known net profit
Net profit is directly reflected in the company's profit statement. The net profit is the operating result left to shareholders holding ordinary shares after paying income tax, paying interest to creditors, paying dividends to shareholders of preferred shares, and considering the non-core operations of the enterprise (government grants, loss of profits such as the sale of assets).
Shareholders can distribute net profits, or they can continue to invest in enterprises to expand reproduction.
Investors like to use price to earning ratio PE (price to earning ratio) to compare the investment value between companies. This indicator is dependent on the company's net profit.
The connection and difference of three and three indicators
From the summary of the discussion of the above three indicators, it can be seen that EBIT and EBITDA do not include the non-core operating gains and losses of the enterprise, nor do they include preferred dividends and taxes; and the net profit includes all of these (as additions and subtractions).
As a corporate shareholder, you can only pay cash dividends based on net profits or invest in companies to expand reproduction; creditors and governments should look more at EBIT and EBITDA, which can reflect the overall value of the enterprise.
Here Qinqin lays a foreshadowing: Enterprise Value (EV) is only the value to equity holders (shareholders)? Or is it valuable to creditors, equity holders, and governments? If we measure corporate value, do we use EBIT, EBITDA or net profit?
Many individual investors (commonly known as Xiaosan) like to pay attention to the company's net profit, but as Qinqin has always advocated, net profit is confusing, and to some extent is the most meaningless financial data. Speaking of which, it is necessary to give you three reasons:
One of the reasons is that net profit is affected by the capital structure of the enterprise. If there are two companies, company A has 50% equity and 50% debt; company B has 100% equity. Even if the two companies have the same corporate value, the PE and net profit they get will vary greatly. For example, GM and Ford, the latter from the perspective of equity investors, the valuation is higher than GM. One of the most important factors is that GM has more debt than Ford, which affects the valuation of its equity value.
The second reason is that net profit is affected by income tax. Two companies with the same corporate value enjoy an income tax rate of 15% and 25%; the two companies enjoy different pre-tax deduction policies. If PE and net profit are used to judge the investment value of these two companies without carefully looking at their different tax policies, is this too arbitrary? So is it more accurate to use EBIT or EBITDA?
The third reason, the net profit is affected by the non-core and non-recurrent business of the enterprise. When creditors and investors analyze the value of the enterprise, they usually do not consider the benefits that some non-recurrent and non-core businesses bring to the enterprise, such as selling fixed assets, obtaining government subsidies, and administrative fines. These are not the core business of the enterprise . Many enterprises in China rely on government subsidies to survive all the year round. Although the net profit of the book is very good, once the government subsidies are removed, they will lose a lot of money. Does such a company still have investment value when the net profit is positive? Unlike net profit, EBIT and EBITDA can eliminate these effects.
In actual work, we must not isolate and analyze these three indicators.
A qualified financial and investment analyst will, on the premise of fully understanding the true meaning of the indicators, comprehensively use the indicators to find out the impact differences between them and make a reasonable explanation.
The ending point of these differences is the story behind the company, which helps us make various decisions, which is the meaning of financial analysis. It is also a competitive advantage where people are superior to machines and not replaced by machines.
How to choose these three indicators
Finally, let's solve the practical problem mentioned in the first article: Under what circumstances should one or a combination of these three indicators be used?
Generally speaking, if analysts want to reflect the impact of capital expenditure Capex, EBIT is better than EBITDA, because the former can capture the impact of Capex through depreciation.
EBITDA is often used to analyze companies that have little impact on capital expenditures, such as software, Internet, and consulting companies. The R & D expenditure of these companies is more important than the expenditure of fixed assets.
In this example, you may prefer to use EBITDA to analyze LinkedIn as it is in accordance with the above "generally speaking" because it is an Internet light asset company. But Qinqin tells you that LinkedIn's capital expenditures are huge, which has a considerable impact on the company's free cash flow and valuation, so EBIT should be used flexibly.
Whether to choose EBIT or EBITDA depends not only on the industry, but also on the stage of enterprise development.
If an enterprise grows rapidly and has a large amount of capital expenditure, EBIT is given priority. If the enterprise has entered a stable and mature period without a large amount of capital expenditure, its impact is not large, and EBITDA can be considered.
In addition, as creditors of banks and other countries in the world, they like to use the ratio of EBITDA to other indicators to constrain the debtor. In the loan contract, the debtor ’s “debt / EBITDA ratio” cannot be higher than a certain number, and the “EBITDA / interest ratio” cannot be lower than a certain A number, otherwise it is a breach of contract, the bank has the right to recover the loan or let the creditors supplement the collateral. The purpose of choosing EBITDA here is to eliminate the effect of depreciation on the cake size. Many companies like to adjust profits by changing the depreciation method, and EBITDA is just not affected by such manipulation.
Finally, we must reiterate that we must not isolate these three indicators and analyze them. A qualified investment analyst must comprehensively use various indicators to find out the impact on the premise of fully understanding the true meaning of each indicator. Differences in impact between them, and make a reasonable explanation.
The foothold of these differences is the story behind the company, helping us make various decisions. This is the significance of financial analysis.
to sum up
Remember, net profit is just the last piece of common cake for shareholders of common stock. The distribution of creditors, government and shareholders determines the size of the final cake.
EBIT reflects the impact of corporate working capital and long-term capital investment, which is similar to the impact of free cash flow by working capital and long-term capital investment, so sometimes EBIT can be regarded as free cash flow.
EBITDA is obtained from EBIT plus depreciation and amortization DA, which is not completely equivalent but similar to operating cash flow.
The reason why EBIT and EBITDA are compared to cash flow is that the first two are easier to obtain than the latter, especially when predicting the company ’s future value.
Thank you for your precious time!
References
