The EBITDA Guide
Running a small business will expose you to lots of new terms and ideas. This is especially true when it comes to accounting. One of the most frequently used accounting measures is EBITDA. This term stands for Earnings before interest, tax, depreciation, and amortization.
There’s a lot of confusing information regarding EBITDA. That’s why we put together this helpful guide. We’ll help you understand EBITDA, how it’s used, and the benefits of using it in your accounting measures. We’ll also explain some of the pitfalls you need to be wary of when looking at EBITDA. Then we’ve got a helpful FAQ section that will cover the most common EBITDA questions.
Use this information to gain a better understanding of this important accounting measure. Doing so will allow you to have a better understanding of your business’s value and worth.
Benefits of Looking at EBITDA
- Understanding the value of your business before you sell it
- Demonstrate the value of a business without legal, earnings suppressing accounting
- Capital structure neutral measure of company performance
- Normalizes company earnings for comparison
EBITDA can mean different things to different people, depending on what their interest is within a company. If you’re interested in acquiring other companies, then EBITDA can be a useful way to normalize certain aspects of those companies to give you an idea of how efficiently they operate. This allows you to make decisions about investments while understanding that tweaking different aspects of the business, such as its accounting practices, debt structuring, location, etc. will allow the company to generate a larger profit for you.
However, if you own a company, then EBITDA can give you different information. For example, it can help you understand the value of your business before you sell it. This allows you to determine a fair price and ensures that you’ll get the maximum value for your company.
Current owners can also use EBITDA to get a better idea about their operational effectiveness. That’s because most private companies structure their accounting practices in such a way so as to reduce earnings as much as possible. That lowers the overall tax liability a company faces.
However, when you use these numbers to analyze your business, you’ll get a distorted understanding of how your business is actually functioning. As a result, it can allow you to better understand where you’re having problems within your company’s structure. It can also let you understand which locations are performing better than other ones by removing a lot of corporate overhead from the calculations.
EBITDA is a way to understand a company’s performance without considering financing decisions, accounting decisions, and its tax environment. This has the potential to revel a wealth of important information about a company.
This is an important measure because financing, accounting, and the tax environment are all situations that can change if the business were to restructure its finances or move locations. As a result, EBITDA gives you a look at what kind of revenue a business is generating in a vacuum. This gives you a better understanding of how the core business operations are functioning.
This figure is also useful for investors, especially those looking to buy a business to run. It allows you to understand how much revenue potential a business has. This can allow you to make informed decisions when you’re choosing between potential acquisitions.
An EBITDA can also be used in the form of an EBITDA multiple. This is a ratio that looks at a company’s enterprise value. That means you can understand its entire market value instead of only understanding the equity value.
An EBITDA multiple is calculated using a company’s enterprise value – it’s market capitalization plus net debt – and compares it to the EBITDA for a given period.
Understanding the EBITDA multiple is important because it includes both debt and equity. This gives you a more complete picture of a company’s total business performance. It’s usually used to evaluate different takeover candidates for merger and acquisition.
Public companies usually have a higher EBITDA multiple, averaging around 8x. Private companies usually have an EBITDA multiple of around 4x. A lower ratio is a sign that a company is undervalued.
Issues with EBITDA
There are some issues with using EBITDA though. We’ll look at some of the main things you should be wary of when using this accounting measure to make decisions about investments and business health
First, since EBITDA doesn’t take depreciation into account, it can make companies with lots of assets look stronger than they actually are. That’s because depreciable assets play a large role in helping a business function. Capital expenditure will be required to replace depreciated assets.
Second, EBITDA can hide some kinds of debt. Specifically, it can hide interest payments to creditors. It doesn’t matter if a company has an EBITDA of $5 million if they’re paying $7 million in interest. That can result in a huge problem if you only look at the EBITDA of a company you’re considering acquiring.
Third, EBITDA can hide problems a company will have in the future. There’s a reason why depreciation exists. It’s a useful metric to show you when certain core assets will need to be replaced. Additionally, by excluding amortization, EBITDA can hide escalating interest and debt payments that a company might have.
Finally, EBITDA doesn’t follow the Generally Accepted Accounting Principles, or GAAP. That means it can become a tool that allows a company’s true nature to be easily manipulated. It allows a company to hide its biggest expense items to seem like it’s doing better than it is.
For example, a retail store needs working capital to purchase inventory ahead of busy sales seasons. If it doesn’t have the cash on hand, then it needs to borrow that money. The earnings it makes on the sales during the season will show up in the EBITDA, but the interest on the debt incurred to generate those sales won’t. That means you might not be getting an accurate look at the company and how it’s performing.
All of these issues show why it’s important to use multiple valuation techniques to determine the true value of a company. Every valuation method can hide different things about a company. Additionally, every valuation can show you different things about a company. Using multiple different methods, including EBITDA, can allow you to get a more complete understanding of the core operating effectiveness of a given business.
EBITDA FAQ Section
This section will answer your questions about EBITDA. We’ve grouped the most common questions into a few different sections. We’ll look at the basic questions about EBITDA, questions about how to evaluate it, questions that compare it to another accounting measure, and then some specific questions about it.
Use this information to understand what EBITDA is so you can use it as a part of your valuation methods while understanding the shortfalls that come with this particular measure.
This section covers the basic questions that people have about EBITDA. We’ll help you understand what it is and how it is used. Use this information to get a better foundation for this important valuation technique.
What Exactly is EBITDA?
EBITDA stands for earnings before interest, tax, depreciate, and amortization. That means it tells you about a company’s gross earnings in a way that makes it easy to compare it to other similar companies. As a result, you can use it as a component of your valuation strategy in order to make sound investment decisions when choosing between different take-over options.
What is Adjusted EBITDA?
Adjusted EBITDA is a measure that only looks at top line earnings before interest, taxes, and depreciation. It’s different from EBITDA in that in normalizes income and expenses. It standardizes cash flow comparisons to allow an apples-to-apples look at two different companies.
What is Amortization in EBITDA?
Amortization is the structure of debt payments that a company will be obligated to pay. For EBITDA it means that different debt structures don’t affect the number generated by the accounting measure.
How to Find EBITDA on Income Statement?
That depends on the layout of the income statement. EBITDA will usually be included near top-line values, as that’s what it most strongly relates to.
What is the Significance of EBITDA?
The significance of EBITDA is that it allows for company valuation to be somewhat normalized. That’s because it excludes debt structuring and accounting mechanisms to give you a picture of a company’s earnings.
EBITDA can be difficult to understand. This section answers the most common questions that people have when it comes to calculating EBITDA. It will also help you understand how to use EBITDA to get to other important accounting and valuation metrics. Use this information to take advantage of the data that EBITDA can provide you.
Why is EBITDA Adjusted?
EBIRDA is adjusted in order to normalize income and expenses. You would do this in order to get a more equitable comparison between two different companies that you are considering acquiring. The adjusted EBITDA allows you to quickly understand how each company’s top-line numbers relate to each other without having to go through their books to understand the different accounting techniques involved.
How do You Calculate EBITDA?
Calculating EBITDA is easy to do. There are two ways you can do it. Either you add non-cash expenses like depreciation and amortization to operating income, or you can take net income and add back taxes, depreciation, amortization, and interest.
What Taxes are Included in EBITDA?
EBITDA includes the SG&A tax categories, so selling, general, and administrative taxes. These include things like property tax, payroll tax, use tax, city and local taxes, and sales tax. This allows you to look at operational performance and have important insights about business effectiveness.
Can EBITDA be Negative?
Yes – if a company is facing operational difficulties then it can have a negative EBITDA. This happens when cash expenses outstrip earnings. It is a sign a company is selling products for less than they cost to make.
Does EBITDA Include Other Income?
Sometimes, it depends on how a company structures their core operations. There is actually a substantial debate among business valuation experts whether or not other income should be included in EBITDA.
How to Calculate Free Cash Flow From EBITDA?
Calculating free cash flow from EBITDA requires understanding the different components of each accounting measure. To get FCF from EBITDA you can use the following formula (EBITDA – D&A)(1-tax rate) + non cash adjustments +/- change in working capital – Capex.
How to Calculate EBITDA from Annual Report?
To calculate EBITDA from an annual report you need to find the operating profit on the income statement. Take this figure and add any expenses from depreciation and amortization. This will give you the EBITDA.
How to Calculate TTM EBITDA?
You can calculate the twelve trailing months EBITDA by taking the income statements that cover those months and adding any TTM amortization, tax, and depreciation expenses. Essentially, the process is the same, but you’ll be using larger numbers and getting larger numbers as a result.
How to Calculate EBITDA from Cash Flow Statement?
There are four steps to finding the EBITDA from a cash flow statement. First, find net earnings, interest expenses, depreciation expenses, income tax expenses and amortization expenses on the cash flow statement.
Second, add the interest expense and income tax expense back to the net earnings. This will give you the EBIT.
Third, add the depreciation and amortization expenses together to find non-cash operating expenses.
Finally, add the non-cash operating expenses to the EBIT. This will produce the EBITDA.
Does Goodwill Impairment Affect EBITDA?
That depends. Goodwill is usually considered as other income. If you think that other income belongs in EBITDA, then goodwill impairment will certainly affect it. Otherwise, no, it won’t.
How to Calculate EBITDA from Gross Profit?
Getting to EBITDA from gross profit is actually fairly simple. You’ll simply need to include operating expenses when you’re calculating earnings. That’s because gross profit differs from EBITDA in what it is actually measuring. EBITDA measures how well a company is operating. Gross profit tells you how much money a company is making. A company can be operating well and still produce a low profit. In the same way, a company can be operating inefficiently and still produce a high profit.
Are Property Taxes Included in EBITDA?
No, property taxes are not included in EBITDA. EBITDA is a financial metric that allows people to analyze operating performance, and property taxes are not an aspect of operating performance.
How to Calculate Depreciation and Amortization from EBITDA?
To determine depreciation and amortization from EBITDA you need to subtract earnings, interest expenses, and tax expenses from the EBITDA figure.
Does EBITDA Include Exceptional Items?
Not usually, EBITDA is designed to give an overall impression of operating performance, so it doesn’t include exceptional items. However, there are some valuation experts that thing that exceptional items should be considered in EBITDA.
Does EBITDA Include Impairment?
That depends on how you think EBITDA should be understood. Some valuation experts think that other income should be included in EBITDA, whereas others disagree. If other income is included in EBITDA, then impairment would also be included.
Is Sales Tax Included in EBITDA?
Sales tax is excluded by EBITDA. It doesn’t reflect a company’s operating performance, and so isn’t included in the accounting measure.
It can be difficult to interpret what EBITDA tells you. This section answers the most common questions people have about how to evaluate an EBITDA. Use this information to understand what the number represents as far as you and your financial decisions go.
What Does EBITDA Margin Tell You?
The EBITDA margin tells you about a firm’s operating profitability as a percentage of its total revenue. You determine the EBITDA margin by taking the EBITDA and diving it by total revenue.
Do You Want a High or Low EBITDA?
That depends on your goals. If you’re looking for a company to acquire, then a low EBITDA generally indicates that a company is undervalued. However, if you’re selling a company then you may want a high EBITDA, which usually coincides with a company being overvalued.
What is a Good EV EBITDA Ratio?
That depends on your goals. A lower EV EBITDA means a cheaper valuation, where as higher EV EBITDA means a higher valuation. If your goals are to obtain a company for as little as possible, then a lower EV EBITDA ratio is in your best interest. However, if you’re trying to maximize the value of a company, then you’ll want the highest possible EV EBITDA ratio.
Why is EBITDA Important to Private Equity?
EBITDA is important to private equity and private equity investors because it is a good measure of a company’s cash flow from operations. That means you can use it to make decisions between different companies to acquire.
What is an Acceptable Debt to EBITDA Ratio?
That depends on your goals and level of acceptable risk. A higher ratio of net debt to EBITDA shows that a company is have large debt issues. This will force it to have a lower credit rating. As a result, it will need to offer higher yields on things like bonds to generate capital.
How to Value a Company Using EBITDA?
If you want to value a company using EBITDA then you’ll need to determine the company’s enterprise value. You can find this by multiplying the company’s multiple by their EBITDA. This will tell give you a valuation for the company as a whole.
What Does a Negative BV EBITDA Mean?
A negative book value EBITDA means that a company is having operational problems or management issues. It usually indicates that they are selling a product for less than that product costs to make.
EBITDA vs Other Accounting Measures
There are lots of different accounting measures that you can use to understand the value of a company. There are also lots of different ways that you can determine if a company is a good acquisition. This section covers questions that compare EBITDA to other accounting measures and metrics. Use this information to get a better understanding of what EBITDA can and can’t tell you about a company.
Is EBITDA the Same as Net Operating Income?
No, EBITDA is a more complex calculation than operating income. That’s because it adds back non-operating expenses into the value, such as amortization and interest.
Why is EBITDA Better than Net Income?
EBITDA gives a normalized measure of income which doesn’t include non-operating expenses. That means it can tell you more about a company’s operating profitability, providing deeper insight into that company’s core operating value.
Can EBITDA be Higher than Revenue?
No, EBITDA is a way to show operating profitability as a percentage of its total revenue. Therefore, the EBITDA can’t be higher than revenue.
Is EBITDA and Gross Profit the Same Thing?
No, gross profit takes SG&A expenses into account. EBITDA excludes most SG&A expenses in order to give a picture of a firm’s operating profitability.
Is EBIT the Same as Pre-tax Income?
No, pre-tax income is a measurement of revenue, whereas EBIT excludes taxes and interest payments. Also, earnings and income are different in relation to valuation measures.
Is EBIT the Same as Net Profit?
No, net profit is all earnings minus all expenses. EBIT excludes interest and tax expenses. EBIT doesn’t measure profits at all.
Is EBITDA Operating Profit?
No, operating profit would include things like expenses from deprecation and amortization. EBITDA explicitly excludes these expenses.
Is NOI an EBITDA?
No, net operating income describes a company’s gross income from operations. EBITDA describes a companies earnings minus interest expenses, tax expenses, depreciation and amortization. Therefore, it’s an indicator of a company’s operational performance.
Why EBITDA is Better than EBIT?
In terms of valuation, EBITDA gives a clearer picture of operational effectiveness. This is because depreciation and amortization are non-cash expenses that don’t reflect how well a company’s operations are functioning.
Is Net Profit the Same as Net Income?
No, income is the amount of money you bring in above the cost of goods sold. Profit is the amount of money that’s left over after you cover all expenses.
Can Net Income be Higher than Operating Income?
No, net income is the operating income minus interest expenses and taxes. Therefore it can’t be higher than operating income itself.
Specific EBITDA Questions
This section covers specific questions that you might have about EBITDA. These questions don’t fall neatly into our other question categories, and may be relevant only for certain niches of people.
What is EBITDA Multiple?
An EBITDA multiple looks at the enterprise value of a company. You can determine the EBITDA multiple by dividing the enterprise value of a company by its EBITDA.
What is the Average EBITDA Multiple?
That depends on several factors, such as the industry you’re in and whether or not a company is private or public. Public companies usually have a multiple of around 8x. Private companies usually have a multiple around 4x. However, these are just general figures. Keep in mind that different industries will have different average EBITDA multiples.
How can Employees Impact EBITDA?
Employees can impact EBITDA through their level of engagement. A higher level of employee engagement results in more productivity and thus more profitability. As a result, making sure your employees stay engaged can be a great way to boost EBITDA.
How to Forecast EBITDA?
You can forecast EBITDA the same way that you calculate actual EBITDA. However, instead you would use forecasted sales and expenses instead of past sales and expenses in your calculations.
EBITDA stands for earnings before interest, taxes, depreciation, and amortization. It is used as a measure of a company’s operational effectiveness. It is one of several different accounting metrics that valuation experts use to value a company.
What Multiple of EBITDA do Companies Sell For?
It depends on several factors. Some companies have been sold for as much as 10 times the value of their EBITDA. However, it depends on what the potential buyers are most interested in and other core fundamentals of the company itself.
What is 4-Wall EBITDA?
A 4-Wall EBITDA is just the EBITDA for a retail store. The 4-wall EBITDA is the EBITDA for the retail store itself. It includes COGS, labor, rent, and other 4-wall expenses. It doesn’t include things like corporate overhead, head-office labor, and so on.
Can EBITDA Multiple be Negative?
Yes, if the EBITDA for a company is negative then its EBITDA multiple can also be negative. This would indicate widespread problems across the company or problems at the very top of the organization, since EBITDA multiples reflect enterprise-level operational effectiveness.
What is Maximum EBITDA Payable as Executive Compensation?
There is no set maximum EBITDA payable as executive compensation. The maximum executive compensation is determined by a corporation’s own guidelines, owners, and board of directors.
Jason is a Senior Author for SBL. He has been working with small business owners like you for the past ten years. He graduated with an MBA and began a career as an independent financial consultant for small businesses in his state.