MONEY TALKS

Credit Series- Myth on EBIDTA

“The company is able to pass on the increase in prices with a monthly/quarterly lag. They have been able to maintain EBIDTA margins YOY inspite of fluctuations in crude”.

 “This company has been able to consistently deliver EBIDTA margins of 10% in last 3 years”.

 I had come across these statements multiple times. Considering how each business is dependent on a core raw material where ultimate price- cost as well as sales- is dependent on a variable or benchmark, we all come across businesses similar to these.

Sensitivity is generally run on the EBIDTA % and conclusion mostly is that increase or decrease in raw material price can be passed on to customers.

But how many times do we consider the situation when even if EBIDTA margin is constant, due to the reduction in benchmark price absolute EBIDTA would be significantly lower.

Take the below example of a large corporate with raw material and finished product dependent on crude.

CRUDE

It was able to maintain constant EBIDTA margin % in first two and last two years.  However absolute amount points to the wide fluctuation in cash generated which would impact the surplus available for repayments.

Start looking at the price trends in clearly identifiable variables and understand that how the gap due to downward movement would be filled in even if margins in % terms would be maintained.

It’s the absolute EBIDTA and not the margins which will impact the loan repayments. 

Closer tracking of these movements will help understand and mitigate the risks in better way rather than only evaluating the financial covenants on DSRA or Debt to cash accruals which would be past historic data and would come after a time lag which may be too late at times.

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