While EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization) is not a generally accepted accounting principle, it can be quite useful for understanding the profitability of a company at a glance, and is highly valued as a measure of performance for business owners and CEOs who need to get a top-level view of their profitability.
EBITDA is especially useful in mergers and acquisitions of small and medium-sized businesses, as it allows the basic performance of any given company to be compared without the complications of financing, tax jurisdiction, assets collected, and debt amortization.
Let’s go deeper into the basics of EBITDA, and why business owners and CEOs should use it to determine the value of their companies.
1. What is EBITDA?
EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization) is exactly what it sounds like. Basically, it’s calculated like so:
EBITDA = Net Profit + Taxes + Interest + Depreciation Expenses + Amortization
Essentially, EBITDA simply represents net income with all tax, interest, depreciation, and amortization expenses added back into it. This allows the profitability of different companies to be compared easily, as it simplifies the financing and accounting decisions of the company in question.
2. Why does EBITDA matter?
EBITDA is often used in valuation ratios, because it’s a very simple metric that can give a high-level overview of a company’s financial health. Many companies interested in buying another company will perform basic, high-level EBITDA calculations at the beginning of the buying phase, and use these as a rule-of-thumb metric to understand profitability and cash flow.
EBITDA first became popular in the 1980s for just this reason – it was used as an indication of a company’s ability to service debt, and was used for leveraged buyouts and corporate valuations.
Now, EBITDA, being a non-GAAP (Generally Accepted Accounting Principles) measure, is not the most accurate measure of profitability. It leaves out the cost of funding working capital and replacing outdated or non-functional equipment, which can be quite large expenses, depending on your industry.
Still, since EBITDA is so easy to calculate, it remains popular for high-level decision-making.
3. How do I use it to value my company?
Begin by obtaining your income statement, cash flow statement, and profit/loss report. These three documents together should include your earnings, tax, and interest figures, as well as your depreciation and amortization expenses.
– Calculate EBIT by subtracting your expenses from your total revenue. This includes amortization, utilities and rent from office buildings or equipment, administrative expenses, and so on. Record this value.
– Sum up your depreciation expenses. These should be found on your cash flow statement, or on your profit/loss report. Record this value.
– Sum up amortization expenses. Amortization is usually listed next to depreciation on cash flow statements or profit/loss reports, as the two are closely related. Record this value.
– Add your EBIT (Earnings Before Interest and Tax) with your Depreciation (D) and Amortization (A). EBIT + D + A = EBITDA! That’s it. The number you see before you is your company’s EBITDA value.
Now, EBITDA is not a comprehensive measure of a company’s health – and it can be manipulated by changing depreciation schedules, amortization schedules, and other data points. Therefore, it’s not to be trusted as a comprehensive valuation of a company – that’s why it’s not a GAAP measurement.
However, if you’re a business owner or CEO looking to do a quick comparison of your company to another, or get an idea of the general health of your company before seeking to sell, EBITDA is a quick, easy way to do so, and can be very valuable when comparing companies across different industries.
If you would like help determining your company’s EBITDA or to learn more about what’s involved with preparing your company for sale, please contact me as our company B2B CFO literally wrote The Exit Strategy Handbook. We can also discuss our free Discovery Analysis for your company.