What is EBITDA and Why is it Important?
by Megan Hiles
Have you ever considered selling your business? Do you anticipate selling in the future? If yes, it’s important that you familiarize yourself with EBITDA and how it could affect the future sale of your business.
What is EBITDA?
EBITDA stands for Earnings Before Interest, Taxes, Depreciation, and Amortization, and measures a company’s operating performance. In the past, investors have typically focused on cash flow, net income, and revenues as their main source of performance measurement. EBITDA has become a more common measurement of profitability because it reflects operational cash flow for a business by excluding non-operating factors, such as internal expenses and taxes.
There is no legal requirement for a company to disclose its EBITDA, but many companies often do. EBITDA is calculated by beginning with your earnings before tax and interest and then adding back depreciation and amortization.
EBITDA = operatingincome + depreciationandamortization
Some argue that EBITDA gives a more realistic view of operations due to the fact that it is removing specific expenses that can skew results of how the company is truly performing.
History of EBITDA
EBITDA was developed in the 1980s as a way for investors to decide whether or not a company would be able to take care of servicing debt in the upcoming years. Occasionally, this measurement would be used on a company that is in distress and in need of financial reconstruction. The use of EBITDA has since spread and become a common measurement in a wide range of businesses and uses.
EBITDA is important because, generally speaking, as EBITDA grows, so does the value of a business. Though EBITDA is not the only value measurement, it is important and universal.
How to Increase EBITDA
- Work on increasing revenue
- Improve cost of sales
- Improve operating expenses
- Diversify your customers
- Diversify your products
- Improve your management team
- Improve cash flows
- Recruit and retain the best staff
- Understand your competition
If you have any additional questions about EBITDA or how to increase EBITDA, please reach out to info@corigankrause.com to become a client.
As an expert in financial management and business valuation, I bring a wealth of knowledge and experience to the topic of EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization). With a proven track record in advising businesses on financial strategies and valuation, I aim to shed light on the importance of EBITDA in the context of selling a business.
Understanding EBITDA:
EBITDA, acronym for Earnings Before Interest, Taxes, Depreciation, and Amortization, serves as a crucial metric in assessing a company's operational performance. While traditional metrics like cash flow, net income, and revenues have historically been pivotal, EBITDA has gained prominence for its ability to offer a clearer picture of a business's cash flow generated from its core operations. By excluding non-operating factors such as internal expenses and taxes, EBITDA provides a more focused view of a company's profitability.
Importantly, EBITDA is not a legally mandated disclosure, but many companies choose to provide this figure voluntarily. Calculated by starting with earnings before tax and interest and then adding back depreciation and amortization, EBITDA is believed by some to present a more realistic view of a company's operations by eliminating specific expenses that might distort the true performance.
Historical Perspective:
EBITDA emerged in the 1980s, originally designed as a tool for investors to assess a company's ability to manage debt obligations in the coming years. Initially applied to distressed companies in need of financial restructuring, EBITDA has since evolved into a widely used metric across various industries and purposes.
Significance of EBITDA:
The importance of EBITDA lies in its correlation with the value of a business. Generally speaking, as EBITDA grows, so does the value of a business. While it's not the sole measurement for business valuation, EBITDA holds universal significance in financial analysis.
Strategies to Increase EBITDA:
- Increase Revenue: Focus on expanding sales and finding new sources of income.
- Improve Cost of Sales: Optimize operational efficiency to reduce the cost of goods sold.
- Enhance Operating Expenses: Streamline and cut unnecessary operating expenses.
- Diversify Customers and Products: Reduce dependency on a single customer or product.
- Strengthen Management Team: Invest in leadership to improve decision-making and operational effectiveness.
- Enhance Cash Flows: Manage working capital efficiently to improve cash flow.
- Recruit and Retain Top Talent: A skilled and motivated workforce contributes to operational success.
- Understand Competition: Stay informed about market trends and competitors to make informed strategic decisions.
In conclusion, EBITDA is a key metric in assessing a company's operational health and plays a pivotal role in determining its value, particularly in the context of a potential sale. For businesses looking to maximize their value, focusing on strategies to increase EBITDA is essential. If you have further questions or require assistance with EBITDA and related financial matters, feel free to reach out.
