You may have come across the term EBITDA and did not fully understand what it means and also what it stands for. If this is the case, give yourself five minutes and take a closer look because it can be important in the value of your business.
Here is what it means and how best to proceed in using it. EBITDA is an acronym for Earnings Before Interests, Taxes, Depreciation, and Amortization. It is commonly used to compare and contrast the net income or financial strength of two or more entities. It is similar to net cash flow but doesn’t include an owner’s salary. So sometimes net cash flow is used, and sometimes EBITDA or net income is used.
Varying Opinions about EBITDAEBITDA is used often to compare companies with similar net incomes and valuations. Companies will usually sell for a multiple of EBITDA so its a way of comparing whether a company is selling for a high multiple or a low multiple. Many factors go into what the multiple is. For more on what factors other than EBITDA go into business valuation, please read Business Valuation Factors. It is essential to keep in mind many factors go into the assessment of a business.
One of the main reasons that EBITDA is misunderstood is the fact that it often gets mistaken for other parameters. Examples of EBITDA being used as a value to substitute Net cash flow are common and yet misleading. It is vital that you understand there is a difference between earnings and cash earnings and they aren’t the same thing. EBITDA doesn’t take into the owner’s salary or expenses such as interest, depreciation, taxes, and amortization.
Considering all these factors, no matter how vital EBITDA is, you don’t want to place too much emphasis on it when determining the strength and position of your business. Its calculation and application overlook many factors that could influence the future of your business. However, seek professional advice and help from business brokers and business intermediaries.
Synergy Business Brokers have been trained and have gained experience to handle valuation to determine the appropriate value of your business. This valuation takes into consideration the most relevant aspects as well as a realistic market approach. This gives you a credible and sound assessment that you can rely on.
If there is disagreement on EBITDA being able to determine the value of a business, then why is it used so often? This calculation is somewhat ubiquitous, in part, because EBITDA takes a very complicated subject, determining and comparing the value of businesses, and distills it down to an easy to understand and implement formula. This formula is intended to generate a single number.
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Check out some of our other articles such as: What’s the difference between an asset sale and a stock sale? When should you sell your company yourself instead of hiring a Business Broker?
