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Economic Income Definition

See Also:
Economic Order Quantity (EOQ)
Accounting Income vs. Economic Income
Economic Production Run (EPR)
Problem With Days Sales Outstanding Example

Economic Income Definition

Economic income is the way for companies to account for changes in the value of a given asset in the market. It generally recognizes unrealized gains, in addition to recognizing realized gains.

A change in market value rather than cash received is the perfect example of an economic income. Economic income or loss recognizes all gains and losses whether realized or unrealized. This differs from accounting income which only recognizes realized gains: gains resulting from an actual business transaction. This defines the difference of accounting earnings vs economic earnings.

For income to be realized it must result from actual business transactions. A change in market value rather than cash received is economic income and not accounting income. When a gain or loss is unrealized it may or may not be accounted for in general. This depends on the placement of the gaining or losing asset in the balance sheet. Despite that this gain or loss may be accounted for, the fact that it is unrealized makes it an economic income or loss. The term economic income was born out of the need for financial accounting income vs economic income comparisons.

Economic Income and Time

Economic income assists companies in knowing the value of an asset if it was sold at a given time. Key to the economic income discussion is the current value of the asset. By then selecting a time period, research can estimate what price will be paid for the asset. This, as compared to estimations of market performance for the time period, can allow for projections of the market value of the asset in the future.

“If the current price of the land is $100,000 and we expect the market to increase by 10% next year, then the value of the land will be somewhere around $110,000 by the end of next year ($100k + $10k = $110k)”.

These measurements allow projections which influence decisions of financing, cash flow, insurance, timing of the asset sale, and other important decisions. Including costs in the decision can expand further to allow for net accounting income vs net economic income comparisons.

Economic Income Example

A perfect example of economic income occurs every day. Realco is a company which sells land. Realco purchased, last year, a piece of land for $100,000. The following year Realco notices the land is selling for $110,000. What is Realco’s economic income?

Realco has not sold the land. As a result it experienced an economic income of $10,000. This is proven by the fact that Realco did not have a transaction in which cash increased by $10,000. The economic income concept revolves around the recognition of income in spite of the fact that no sale has taken place.

If Realco sold the property, then it would have experienced an accounting income. Their land was sold for $10,000 more than initially worth. Thus, Realco has a realized gain of $10,000. The accounting earnings vs economic earnings calculation is the same: The difference is whether Realco gains $10,000 from the sale or not.

$110,000 (revenue from sale) – $100,000 (cost of land) = $10,000 (profit from sale)

economic income           accounting income

$10,000                   $10,000

In addition to monitoring market value changes, economic income provides a place holder for an asset in company financials. This allows for managerial accounting income vs economic income decisions. Without economic income, you would only account for an asset when sold or purchased. Economic income allows the monitoring of an asset between the transaction. At the time of accrual accounting income vs economic income evaluations are not the most important matter. They do form an important issue, however, with the natural business cycle changes that result from time.

economic income definition


Debt to Equity Ratio

Debt to Equity Ratio Definition

Debt to equity ratio defined as an indication of management’s reliance to finance its asset on debt rather than on equity. It measures a company’s capacity to repay its creditors. This ratio varies with different industry and company. Comparing the ratio with industry peers is a better benchmark.

Debt to Equity Ratio Meaning

The debt ratio means an indication of the gearing level of a company. A high ratio means that a company may be over-leveraged with debt. This can result in high insolvent risk since excessive debt can lead to a heavy debt repayment burden. However, when a company chooses to rely largely on equity, they may lose the tax reduction benefit of interest payments. In a word, a company must consider both risk and tax issues to get an optimal debt to equity ratio explanation that suits their needs.

Debt to Equity Ratio Formula

The debt to equity ratio formula is listed below:

Debt to equity = total debt / total equity

Calculation of Debt to Equity Ratio

Debt to equity ratio calculations are a matter of simple arithmetic once the propper information is complied. Debts will include both current liabilities and long term liabilities.

Equity will include goods and property your business owns, plus any claims it has against other entities.

For example, a company has $10,000 in total debt, and $40,000 in total shareholders equity.

Debt to equity = 10,000 / 40,000 = 0.25

This means that a company has $0.25 in debt for every dollar of shareholders’ equity.

Debt to Equity Ratio Example

For example, Shari has started a residential real estate company which has grown to success. Though the market is tough, Shari has protected her cash account in order to deal with what the future holds. Shari now needs to perform debt to equity analysis to make sure she has not become over-leveraged in her company. This could cause problems with bank loans, her company free cash flow, and more.

Shari contacts her controller for debt to equity accounting questions. She knows that there is no debt to equity calculator, so she is willing to wait for some concrete results.

$10,000 in total debt and $40,000 in total shareholders equity.

Debt to equity = $10,000 / $40,000 = $0.25

Her controller finds that she is in perfect standing. Her company, though near its limit, does not have too much debt. It has enough cash to survive common issues which face the residential real estate industry.

She is satisfied that she has followed the path of a responsible business owner. Because she is so used to putting out fires, she is content with the status quo of her company’s regular monthly profits. Shari looks forward to her next quarter.


For statistical information about industry financial ratios, please click the following website: www.bizstats.comand

debt to equity ratio

See Also:
Financial Ratios
Debt Ratio
Debt Service Coverage Ratio (DSCR)
Free Cash Flow


EBITDA Valuation

See Also:
Valuation Methods
Success Is Your Business
Self-Liquidating Loans
What is dilution, how is it calculated, and how should you manage it?
Which Bank to Choose?
Calculate EBITDA
Adjusted EBITDA

EBITDA Valuation Method

There are multitudes of ways to value a company, as well as specific equity and debt claims on a company’s assets. One is the EBITDA valuation method, which relies on a multiple of EBITDA to arrive at a company’s enterprise value.

The definition of enterprise value is the total value of a firm’s equity and debt. It can also be thought of as the total market value of a company’s expected cash flow stream. A company’s EBITDA is a measure of that stream. Furthermore, EBITDA is a company’s net income with tax, interest, depreciation, and amortization expenses added back. It is not an exact measure of a company’s cash flow, but it is one which has gained wide acceptance in the banking and investment communities.

Use the following enterprise valuation formula:

Enterprise Value = Multiple * EBITDA

where EBITDA is typically projected for the next twelve months. Sometimes, the amount used is the actual EBITDA of the company over the last twelve months. Label it as “LTM EBITDA.”

EBITDA Valuation Multiple

Base the multiple on comparable actual sales transactions occurred recently in the company’s industry. Often, one will use the derived multiples of publicly traded companies in the industry in addition to or in lieu of actual transactions.

Also, while you may use a single value for the EBITDA multiple, you often get a range. This range is based on the distribution of comparable multiples, with abnormally high or low multiples excluded so as to provide a useful range for the end user of the valuation.

Valuing Equity Using the EBITDA Valuation Method

Use the EBITDA valuation method to value a company’s total equity. After arriving at the company’s enterprise value using the formula described above, subtract the net debt of a company to determine the value of the equity claim on the firm’s total cash flow. Methods used to directly value equity adjust the firm’s cash flow to yield the cash flow available to shareholders. This is also known as “Free Cash Flow to Equity.”

Use the following formula to value equity using the EBITDA valuation method:

Equity Value = Enterprise Value – Total Debt – Cash and Cash Equivalents

Problems with the EBITDA Valuation Method to Value Equity

The primary problem is that this method relies on EBITDA as a measure of a firm’s cash flow, ignoring other significant factors which can impact a company’s cash flow, such as changes in working capital and capital expenditures. If you’re looking to sell your company in the near future, download the free Top 10 Destroyers of Value whitepaper to learn how to maximize your value.

ebitda valuation

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ebitda valuation


EBITDA Formula

EBITDA Formula

In order to completely understand the concept of EBITDA, an intelligent idea is to visualize the formula concept. Express the EBITDA calculation formula as follows:

EBITDA = Revenues – Costs (excluding interest expenses, taxes, depreciation, and amortization)

or, if a person wants to view EBITDA in terms of the excluded expenses listed above, another way to calculate EBITDA is: EBITDA = Net Income + Interest + Taxes + Depreciation + Amortization

EBITDA Ratio Analysis

Use EBITDA in accounting ratios that compare the profitability of different companies in the same industry. It is important to have a preferable EBITDA so that you can make positive estimates about your company for the future. At the same time, it is just as important, if not more so, to have a positive EBITDA for outside observers. For example, a ratio used to compare profitability is the EBITDA margin ratio. Calculate it using the following equation:

EBITDA Margin Ratio = EBITDA/Sales

The idea is that excluding interest, taxes, depreciation, and amortization gives a clearer picture of a company’s operating performance. More specifically, a company can be viewed with no stings attached using the calculation of EBITDA. Essentially, EBITDA is the skeleton and necessary structure functions and costs of the company. Also use EBITDA to measure the ability of a company to service its interest bearing debt, through the use of the EBITDA coverage ratio. Calculate EBITDA coverage ratio using the following equation:

EBITDA Coverage Ratio = EBITDA/Debt Service

EBITDA Valuation

Value companies using a EBITDA valuation multiple. Calculate the enterprise value of a company using a multiple of its annualized EBITDA. Express this as:

Enterprise Value (EV) = Multiple * EBITDA

where the multiple is derived from an average of comparable transactions in the company’s industry. To use this method to value a company’s equity, subtract the company’s total debt less cash (known as net debt) from its enterprise value:

Equity Value = Enterprise Value – Total Debt – Cash

If you want to find out more about how you could utilize your unit economics to add more value to your organization, then click here to download the Know Your Economics Worksheet. Shape your economics to result in profit.

ebitda formula

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ebitda formula

See Also:

EBITDA Definition
EBITDA Valuation


EBITDA Definition

See Also:
EBITDA Definition
EBITDA Formula
Calculate EBITDA
Discounted Cash Flow Analysis
Cost of Capital Funding
Capital Asset Pricing Model
Discount Rates NPV
Adjusted EBITDA

What is EBITDA?

EBITDA defined is earnings before interest, taxes, depreciation, and amortization. It measures a company’s financial performance by computing earnings from core business operations, without including the effects of capital structure, tax rates and depreciation policies. It is used as a proxy for a company’s operating cash flow and is not defined under GAAP. EBITDA is often used to value a company, with the enterprise value of a company calculated as a multiple of its EBITDA.

EBITDA is usually expressed in industry on an annual basis, though just like any other earnings or cash flow measure it is also expressed on a quarterly or monthly basis. While last year’s EBITDA may be useful in assessing the performance of a company close to the start of the following year, it will lose its timeliness later on during that following year. To address that, you will often see a company’s EBITDA given for the last twelve months. Express it also as “LTM EBITDA.”

Also, use projected EBITDA for the next year, or next twelve months. It is often seen on a company’s forecasted or budgeted income statement.

EBITDA Problems

Factors that are ignored in EBITDA do have a material effect on a company’s cash flows. For example, the EBITDA calculation ignores changes in working capital, investing cash flows such as capital expenditures and asset sale proceeds, and financing cash flows such as proceeds from the issuance of equity, dividends and loan payments. EBITDA will also provide a misleading measure of cash flow for companies that require significant and recurring investments in fixed assets.

In addition, EBITDA, like other earnings and cash flow measures, can be manipulated by adjusting a company’s revenue and expense recognition policies.

For companies which exhibit stable working capital requirements, EBITDA can be a useful estimate of operating cash flow. In addition, EBITDA can be a useful estimate of total cash flow if investing and financing cash activities are relatively small. EBITDA’s wide acceptance as a measure of operating performance and cash flow makes it useful. But it is important to understand its limitations. If you require an accurate measure of a company’s operating cash flow or total cash flow, then you may have to disregard its EBITDA. Instead, focus on the measures of operating cash flow and total cash flow reported in its Statement of Cash Flows. EBITDA is a great indicator of value. If you’re looking to sell your company in the near future, download the free Top 10 Destroyers of Value whitepaper to learn how to maximize your value.

ebitda definition

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Access your Exit Strategy Checklist Execution Plan in SCFO Lab. The step-by-step plan to get the most value out of your company when you sell.

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Click here to learn more about SCFO Labs

ebitda definition


Earnings per Share (EPS)

Earnings per Share (EPS) Definition

The earnings per share or EPS is the amount of profit that accrues to each shareholder based on their percentage ownerships or amount of shares owned within the company.

Earnings per Share (EPS) Explained

The earnings per share ratio is often a good measure of how a company is doing from year to year and is used by many investors in the market. However, companies know that the EPS is often a measure of how they are handling their businesses. This leads several companies to manipulate the EPS ratio. The ratio can be manipulated if the company were to buy or sell its own shares in the market, referred to as Treasury Stock. The net income aspect can also be manipulated through the recognition of revenue as well as other ways.

Earnings per Share (EPS) Formula

The EPS equation is as follows:
(Net Income – Preferred Dividends)/Shares Outstanding

Earnings per Share (EPS) Example

Tim is trying to calculate the EPS for Wawadoo Inc. He was given the following information to solve the problem.

Operating Income – $350,000
Interest expense – $20,000
Tax rate – 34%
Shares outstanding – 100,000 common (no preferred)

Tim will make the EPS calculation as follows:
$350,000 – (350,000 * .34) – $20,000 = $211,000 = Net Income
$211,000/100,000 = $2.11/share = EPS

See Also:
Price Earnings Growth Ratio Analysis
Price Earnings Ratio Analysis
Gross Profit Margin Ratio Analysis
Net Profit Margin Analysis
Financial Ratios


Debt Service Coverage Ratio

See also:
Operating Income (EBIT)
Financial Ratios
EBITDA Definition
Loan Agreement
Time Interest Earned Ratio Analysis
Net Income
Fixed Charge Coverage Ratio
Times Interest Earned Ratio
Free Cash Flow

Debt Service Coverage Ratio

The debt service coverage ratio (DSCR) is a financial ratio that measures the company’s ability to pay their debts. In broad terms the DSCR is defined as the cash flow of the company divided by the total debt service.

A DSCR > 1.0 indicates that the company is generating sufficient cash flow to pay their debts. A DSCR < 1.0 should be a cause for concern because it indicates that the company is negatively cash flowing.

Debt Service Coverage Ratio formula:

DSCR calculation = EBIT divided by (interest + (principal/ 1-tax rate)

In some cases in calculating the debt service coverage ratio EBITDA is used instead of EBIT since EBITDA is a closer approximation of cash flow. When calculating the debt service ratio denominator leases should be included along with other debt service costs.

Debt Service Coverage Ratio (DSCR) example:

Net Income = $643,800 Interest Expense = $240,000 Taxes = $331,655 Principal Payments = $300,000 Tax Rate = 34%

DSCR numerator = EBIT = $643,800 + $240,000 + $331,655 = $1,215,455

DSCR denominator = interest + (principal payments / (1-tax rate)) = $240,000 + ($300,000 / (1-34%) = $695,545

DSCR = $1,215,455 / $695,545 = 1.75

Uses of Debt Service Coverage Ratio:

The DSCR is used as a financial tool for trend analysis. By following the increase or decrease of the DSCR over time a company can determine if they are building liquidity in the businessBenchmarking the DSCR against other companies in similar industries is useful in setting goals for the corporation to attain.

Finally, the DSCR is often used in loan covenants for triggering a default if deteriorating financial results occur.

 debt service coverage ratio


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