Financial Accounting for Managerial Decision Making

Usefulness of EBIT for financial analysis

EBIT stands for the earnings before income and tax and EBITDA stands for earnings before income and tax as well as depreciation. EBIT is also known as operating profit of the business which is computed by subtracting all operating expenses from the gross profit. Operating expenses are those expenses are those expenses which are made on daily basis as usual by the business firm. EBIT or earnings before interest and tax have due importance for the firm because it reflects extent to which firm have control on its direct and indirect expenses in the business (Bouwens,  De Kok and Verriest., 2019. If earnings before interest and tax are low then it means that firm is not able to control its expense or its business reach at saturation point and due to this reason revenue is low in the business. In such kind of situation investment must not be made in any company. This is because if earning before interest and tax is already low then in that case due to tax payment and interest payments profit will reduce further which is not good for the firm. Hence, firm with low earning before intertest and tax are not considered good from the investment point of view. On other hand, there is another term EBITDA which is also very common and have due importance for the firm. In calculation of earnings before interest, tax and depreciation interest, tax and depreciation are taken into account in order to compute earning amount (Rodano and Sette, 2019). There is difference between earning before interest and tax (EBIT) and earnings before interest and tax as well as depreciation (EBITDA). In calculation of EBIT only interest and tax amount are taken in to account but in case of EBITDA both interest, tax and depreciation amount is considered. Thus, it can be said that earnings before interest, tax and depreciation as well as amortization give broader picture of earning then earnings before interest and tax (EBIT). Depreciation is considered as non-cash expenditure because it is not expense that is made in cash in the business. With passage of time value of the asset decline and due to this reason is value decrease. Value by which asset value reduce is considered as depreciation. It is considered as expense because due to it firm have to make expenditure to buy new machine or to repair it if not working. Machine need to be repair because its value decrease and not able to work efficiently (Pongrangga and Kurniawati, 2020). Hence, depreciation is considered as expense and due to this reason, it is also very important for one to consider EBIT and EBITDA while evaluating company earning. 

It can be seen from the table that is given in the appendix that EBIT margin in the year 2015 was 0.36% which decline to 0.80% in the year 2016 but further this percentage increased to 2.59% in the year 2017. Hence, it can be said that there is consistency in the GSK performance. On other hand, in case of EBITDA Margin it can be seen that EBIT Margin value was 53% in the year 2015 and it reduce to 17% in the year 2016. Further in the year 2017 EBIT Margin value was 24%. So, it can be seen that EBITDA margin also fluctuate consistently from year 2015 to 2016 it declines sharply which is a matter of concern for the firm. Main reason behind sharp decline in the EBITDA Margin is that firm earn less profit on the investment amount. Thus, GSK is not right for investment because its business is fluctuating at rapid pace.

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In the calculation of EBITDA profit on disposal of interests in associates is taken into account because it is non-recurring in nature and results due to business operations.

Usefulness of EBITDA for financial analysis

EBITDA which is also known earning before interest, tax and depreciation as well as amortization have a very high importance for the firm because it reflects the overall performance of the firm. In calculation process interest, tax and depreciation as well as amortization is taken into account. EBITDA value if is very low then it means that operating expenses burden is very high on the business firm ( Pinto, 2020). By looking at the value of the EBITDA one can easily estimate likely impact of tax, interest and depreciation and amortization on the firm profitability. Overall, it can be said that through income statement one comes to know about the company performance but through EBITDA vale when become able to more accurately track company performance.

Evaluation of statement

a) “The new revenue recognition standard requires companies to break down their activities into obligations and this drives the recognition model”

Yes, follow up of standard will assist stakeholders in knowing revenue that is earned from multiple sources. Through relevant information one come to know about stream through which higher amount of profit is earned (du Jardin, Veganzones and Séverin, 2019). Thus, it can be said that investors in better way get information about reason in terms of revenue that is responsible for low EBITDA.

b) “Depreciation, applied systematically, produces an accurate asset valuation”

It is true that depreciation is if accurately applied on the assets then their accurate value can be estimated in proper manner. It is well known fact that every year firm charge depreciation on the assets and identify their value but sometimes asset value decreases more than its value that is estimated by the company then in such kind of cases business firm usually do impairment of assets and identify their actual value. Thus, it is rightly said that depreciation, applied systematically then in that case accurate asset valuation can be done by the business firm. It can be said that there is huge importance of the depreciation as a tool that is used in the asset valuation (Sharma, 2019). Fixed rate of depreciation is charged every year on the assets and sometimes value decline more than percentage considered for depreciation. Hence, revaluation of assets must also be done so as to estimate value of the asset accurately and in proper manner.

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CONCLUSION

On the basis of above discussion, it is concluded that there is significant importance of the EBIT and EBITDA metric for the investors. This is because both these tools indicate the earning of the firm and firm ability to control expenses in the business. Both these tools also reflect extent to which interest and tax have impact on the firm performance. Thus, it is very important for the investor to make use of both these metrics to evaluate firm financials.

APPENDIX

Table 1EBIT margin

Table 2EBITDA margin

Table 3EBITDA

Table 4EBITDA

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