Understanding the Basics of EBITDA.

Ever wondered how companies get valued when they’re bought and sold? One of the most important numbers people look at is EBITDA. It’s a bit of a mouthful (Earnings Before Interest, Taxes, Depreciation, and Amortization), but it’s key to understanding a company’s financial health. Think of it as a way to see how much money a business is really making from its operations.

EBITDA: The Basics

EBITDA isn’t just for big M&A deals. Traders, analysts, portfolio managers, and even lenders all use it. It helps them figure out a company’s value and its ability to pay back debts. While EBITDA gives a great snapshot of performance, it’s not the whole picture.

If you’re thinking about selling your business someday, understanding EBITDA is super important. Knowing how it’s calculated can help you show off your company’s financials in the best possible light, making your post-sale cash flow look amazing to buyers. Investors often use EBITDA to figure out a company’s enterprise value, and buyers usually offer a multiple of EBITDA when making an offer.

EBITDA vs. Cash Flow: Clearing Up the Confusion

A common misconception is that EBITDA and cash flow are the same thing. They’re related, but definitely not identical. EBITDA is a useful measure of a company’s operational profitability, but it doesn’t tell the whole story. EBITDA is more like a proxy for pre-tax operational cash flow. It gives an estimate of the cash flow you might expect after a sale. By leaving out things like depreciation, amortization, debt, and taxes, EBITDA lets buyers compare different companies on a more level playing field. It focuses on earnings before those expenses, giving a useful, yet not perfect, idea of cash flow. Cash flow is a more complete picture of a company’s financial health, as it shows how much cash it has available for operations.

Adjusted EBITDA: Making Your Company Even More Attractive

Sometimes, a company has unusual expenses or income that aren’t part of its regular operations. That’s where adjusted EBITDA comes in. It takes those one-time or unusual items out of the equation to give a clearer picture of the company’s true operating performance. This is especially important in M&A deals, because it shows what the earnings might look like under new ownership.

Think of it this way: adjusted EBITDA helps paint a more realistic picture of your company’s future profitability, making it more appealing to potential buyers and helping everyone agree on a fair price. Common adjustments include one-time expenses or income, owner-related expenses, non-cash expenses, and other non-operational items.

Photo by Nick Fewings on Unsplash