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EBITDA

The best measure to use when determining company value

Profits According to EBITDA

What is EBITDA?

  • EBITDA (Earnings Before Interest, Tax, Depreciation and Amortization)
  • Meaning the number of dollars flowing off the business after all “real” monthly operating expenses are paid
  • Starting Points for determining EBITDA:
    • Tax returns
    • Yearly cash flow statement
    • Best guess – back of the envelope
  • Earnings Before (EB):DOES NOT include:
    • Owner expenses: items paid beyond what would be needed to hire an outside manager (and yes that means the airplane)
    • Interest (I): as it is about how you finance the business not operate it
    • Taxes (T): as again they are based on many of non-operating choices
    • Depreciation and Amortization (DA): As with interest, these are based on how you finance the business, not operate it

Why EBITDA?

We use EBITDA because it is the best measure of operating profit. It excludes two big items a buyer (and the capital market) does not need to see to understand the financial performance of the business:

  1. Owner’s Expenses: What the buyer cares about is how much “cash” the business will produce in the future for them as the new owner. Thus, we remove everything accept what it would cost to hire an outside manager to do the existing owner’s job.
  2. Balance Sheet: The buyer does not care how you financed the business, or how/why you paid the taxes you did. When they own it they will do their own financing (from zero debt to fully loaded) and they will pay their own taxes based on outside advice.

 

Quick Start:  Our Discover Assessment asks for two numbers: Revenue and Profit (EBITDA)

  • Revenue: the business’ yearly sales
  • Profit (EBITDA): the net after all “operating expenses” are paid
    • Many owners do not know their EBITDA. THIS IS OKAY! The business owners “first best guess” to start Discover is good enough.
    • This is where you can begin to be the Trusted Advisor.

Basically: Enterprise Value is based on the business as a stripped-down operating engine that generates revenue and free cash flow (profit).

 

Calculating EBITDA

See our downloadable PDF to learn more about EBITDA.