If you are considering selling your company or investing in another, you are likely familiar with the term “EBITDA,” which stands for earnings before interest, tax, depreciation, and amortization. In simplistic terms, EBITDA measures a company’s operating performance, including its ability to generate cash flow.
EBITDA is almost always the key investment consideration, but it shouldn’t be used in a vacuum. Our team has experienced the value of EBITDA firsthand – as well as the drawbacks. See below for our at-a-glance guide to using the metric.
Why is EBITDA important?
EBITDA allows investors to focus specifically on operating profitability, which is important when comparing multiple companies across a single industry or companies functioning within different tax brackets. EBITDA is typically used as a proxy for cash flow and the amount of profit that can be made from its current assets and operations.
How is EBITDA different from other metrics?
This form of evaluation is capital structure neutral. EBITDA does not consider financial and accounting decisions or the current tax environment; it’s an evaluation solely based on operating income. As a result, it is not affected by a company’s means of financing – debt and/or equity – nor does it take into account non-cash expenses like depreciation.
Where EBITDA can go wrong…
Because business owners may or may not have financial statements which follow Generally Accepted Accounting Principles (GAAP), investors have to operate at the discretion of the business owner. This means that it’s the responsibility of the investor to identify how EBITDA is being calculated, as well as to analyze if the items included have been carried over from one reporting period to the next. Most investors want a company’s financial statements to be audited in detail by a certified public accountant (CPA) or they will require a detailed quality of earnings in their due diligence period.
While EBITDA can be deceptive if applied incorrectly, when it comes down to it, the metric is one of the most popular operating measurements used by analysts. While we always recommend using EBITDA when considering an investment, it’s important to do the due diligence required to maintain your own confidence in the calculation. Be sure to consider other factors such as net working capital, required recurring capital expenditures and many others…
Our team of advisors at Symmetrical can guide you through the evaluation process and explain the role that EBITDA plays in closing a deal. Contact us today for more information.