Starting a business is exciting. Running a business is rewarding. But what about exiting a business? While business owners have a deep knowledge of their business and often reap huge rewards, both on a personal and financial level, most owners do not know what to do when they are ready to retire and/or sell the business. Even more, they do not know what their business is worth. To give you an idea of where to start, let's take a look at one of the most valuable tools at your disposal - your company’s EBITDA.
What is EBITDA?
EBITDA is an acronym for Earnings Before Interest, Tax, Depreciation, and Amortization. Analysis of your trailing twelve months’ EBITDA is the most common method business owners, and potential buyers, use in order to arrive at a business valuation. Each of the categories below should be listed on your business’ tax returns and financial statements and are defined as follows:
- Interest: This is the amount of money you pay out as interest on any debts, credit cards, and the like.
- Tax: Taxes you pay through your business to the government and regulatory authorities in the form of taxes, which includes, in certain circumstances, payroll taxes tied to wages.
- Depreciation: The value of tangible assets, such as furniture, fixtures, vehicles, and equipment, that are “written off” over time as the value decreases due to age, damage, or heavy use.
- Amortization: Like Depreciation, the value of intangible assets, such as goodwill on the purchase of a business, can also be “written off” over time.
Calculating Your EBITDA
The formula used to calculate EBITDA is a straightforward one, as indicated below:
Earnings Before Interest, Tax, Depreciation, and Amortization = Net Income + Taxes + Interest Expense + Depreciation + Amortization
Each industry has its own rule of thumb multipliers that can then be applied to the business’ EBITDA to determine the overall valuation. Thus, the higher the EBITDA, the better. However, the true measure of valuation will be determined when your business is compared to other businesses of comparable size within the same sector or industry.
Using EBITDA in Business Valuation
In some instances, EBITDA can be taken as a measure of a company's financial health in general, as some consider it a viable alternative to a net income statement, especially in sectors where intangible assets such as intellectual properties (software, talent, etc.) may not be adequately represented on a balance sheet.
Many also believe that EBITDA provides an effective way to clearly represent the growth trends and profits to interested shareholders and decision-makers. It is argued that those wishing to acquire a business will have a clear picture of the company's ability to pay back its debts by looking at what is known as the outfit's EBITDA to Interest Coverage Ratio.
Even so, there are those that find fault with EBITDA as an exclusive valuation tool because it might obscure the impact of such factors as debt profiles, capital investment costs, and tax burdens.
How We Can Help
EBITDA, while an incredibly useful metric for company valuation, should be used in conjunction with other sources of information for the most useful and accurate results. That is where we can help. Private Practice Transitions has a team of specialists standing by to use the latest tools, including industry trend analyses, transaction comparisons, revenue trend identification, Seller's Discretionary Earnings (SDE), and many more to give you a professional Opinion of Value. Whether you are buying or selling, talk to us first. You will be glad you did.
