A Brief Introduction to EBITDA

When assessing a company that you are thinking of buying, there are multiple measures you can use to gauge the profitability and general earning potential of this target company. One figure that can be used is EBITDA – earnings before interests, taxes, depreciation, and amortization. This calculation takes EBIT one step further by taking away the depreciation and amortization expenses of a company. EBIT, which is simply earnings before interests and taxes, can simply be called operating profit. 

Who Makes Use of EBITDA?

Citing EBITDA when selling a company is often not intentionally misleading. A more proper term would be “error by omission.” Business owners who simply wish to highlight how much money their business brings in will often use EBITDA to point out their perceived superiority among the competition. For companies in certain situations and industries, this makes sense. Technology companies in their early stages can highlight their EBITDA, as can companies with significant assets and debt loads. 

Potential Pitfalls of EBITDA

Some of the criticisms for relying too heavily on EBITDA come straight from the acronym. Knowing the income generation capacity for a business is helpful, but many say it doesn’t give you the full picture. Potential buyers of a company will want to know the amount the target business spends on expensive assets and everything else required to generate the EBITDA. 

One other criticism of EBITDA is the simple fact that it is not an accurate measure of overall financial performance according to the generally accepted accounting principles (GAAP). Because it is not a GAAP-approved figure, there is a lack of uniformity among companies who do report EBITDA. 

Example

Let’s say you are thinking about acquiring a pizzeria and you wish to know the company’s EBITDA. The current owner has not furnished EBITDA for you, but you are able to calculate the figure based on balance sheets and other financial statements. 

You notice that, in one year, the restaurant’s net profit is $500,000. You then find the item on the list that shows expenses related to depreciation and amortization, which is $200,000. This covers the cost of the pizza ovens, the deep freezer, and other capital investments. With the amount of interests and taxes added back to the figure, you calculate that the pizzeria takes in around $1,200,000 each year. That gives you a good idea of how much the restaurant sells per month, weekend, day, etc. 

Conclusion

EBITDA can be a useful metric to know about your company or another business. However, it is just one piece of the puzzle when it comes to knowing the full financial performance and capability of a particular company. So, what else do you need to know? We’d love to discuss your entrepreneurial plans and help you get there. Call Soterian today at 704-755-5145 to connect with our team.

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