EBITDA – an introduction
EBITDA is an important metric as it measures your operational profitability which is one of the key metrics used by investors to assess your business. EBITDA is viewed either as an absolute monetary value or as a % (EBITDA margin).
What is EBITDA?
EBITDA is your earnings before interest, tax, depreciation and amortisation and is seen as a measure of your operating profitability. Although it’s often similar to your operating profit, EBITDA is a measure that is more reflective of cash. Investors look at EBITDA when considering investments and benchmarking businesses against each other.
EBITDA can also be used as an earnings basis for valuation methods (earnings multiples).
Why is EBITDA so important?
EBITDA provides you with a snapshot of short-term operational efficiency. It ignores the impact of non-operating factors such as interest expenses, taxes, or depreciation/amortisation of assets, so the result is a metric that’s a more accurate reflection of operating profitability.
If you’re looking to fundraise or sell your business, understanding your EBITDA can help you determine your business’s valuation or see how potential investors will gauge the health of your company.
The reason institutional investors focus on EBTIDA is that they ignore interest and non cash movements when assessing a business because they can often implement different debt or equity instruments with are more cost efficient.
What is a good EBITDA or EBITDA margin?
Different sectors will have different measures of what constitutes a ‘good’ EBITDA or EBITDA margin. Therefore, EBITDA and EBITDA margin are more useful to benchmark your business against historic results, forecasts and competitors.
It’s also important to note that EBITDA margin on its own doesn’t always indicate the full picture. While it’s a useful measure of profitability, it doesn’t consider the cost of your debt. If you’re paying high interest on your debt to finance your operations, your performance may not be as healthy as EBITDA suggests.
What does EBITDA look like?
How do you calculate EBITDA?
The formula to calculate EBITDA is:
EBITDA = Revenue – cost of sales – operating expenses
An alternative method is to work back from net profit by adding back components to get to EBTIDA, like this:
EBITDA = Net profit/(loss) + interest + tax + depreciation + amortisation
The formula to calculate EBITDA margin is:
EBITDA % = EBITDA / Total revenue
EBITDA worked example
If a company has the following, it’s EBITDA would be £200,000, calculated like this:
- Revenue: £1,000,000
- Cost of sales: £400,000
- Operating expenses: £400,000
- Interest expense: £30,000
- Depreciation/amortisation: £50,000
- Tax: £30,000
- Net profit: £90,000
EBITDA = £1,000,000 - £400,000 - £400,000 = £200,000
Alternatively, it can be calculated as follows:
EBITDA = £90,000 + £30,000 + £50,000 + £30,000 = £200,000
EBITDA margin is calculated like this:
EBITDA margin = £200,000 / £1,000,000 = 20%
Conclusion
EBITDA allows you to view a snapshot of your business’s operating performance to easily benchmark against competitors, historic trading and targets. It is a popular metric with investors. By understanding this metric, you will be able to assess how potential investors may view your business success.
