You may have heard the term EBITDA tossed around in business-related conversations and wondered what it is and if you should be concerned about it when it comes to your business. EBITDA stands for Earnings Before Interest, Taxes, Depreciation (and) Amortization. It is a way of analyzing a business’s income statement and is often used by investors, particularly financial investors. Let’s look at how to compute EBIDTA and what it tells us about a business without getting too deep into the weeds. What we cover will be enough to help you, as the owner or executive management team, to know if and when you need to look at your business’s EBITDA.
HOW TO COMPUTE EBITDA
The basic formula for EBITDA =
Net Income (Loss) + Interest paid + Taxes + Depreciation + Amortization.
Interest paid speaks of interest paid on business-related loans.
Taxes paid refers to state and regional taxes paid in relation to the business. It does not include any operational-related taxes, such as payroll taxes.
Depreciation and amortization are expenses taken over the useful life of capita assets and asset intangibles, for example, goodwill.
There are more advanced computations of EBITDA, but the basic computation shown above is mainly used in business.
WHAT ABOUT MY BUSINESS DOES EBIDTA RELAY?
As mentioned earlier, EBIDTA is used mainly by (financial) investors who are looking at a business’s financial position. Two things investors want to know are:
1) what is the worth of the business?
2) What value does the business possess?
Looking just at the net income does not give an accurate picture of a business’s worth because the net income includes non-operational expenses. Non-operation means that an expense does not impact the company’s day-to-day running.
For example, depreciation and amortization are not actual funds a business spends in a given month or year. They simply represent an offset of the usefulness of an asset. Likewise, interest paid on a loan does not impact the daily running of a business; it merely reflects a portion of a payback on money borrowed.
Therefore, to accurately analyze a business’s worth, all expenses that do not impact the running of the business need to be eliminated; EBIDTA is the result of such an elimination process.
Investors are mainly interested in the value a business has. This informs the investor if investing in the business will yield any returns. If there are no returns, there is no financial benefit for the investor to invest funds into the business. While net income shows a business’s earnings or losses for a given period, EBITDA shows the business’s ability to continue or, said differently, it shows a business’s ability to continue to be profitable.
SHOULD A BUSINESS COMPUTE EBITDA?
One reason a business should compute EBITDA, as mentioned earlier, is to analyze its continuous profitability potential and how well a company is operating. This will help in making crucial business decisions.EBIDTA will help potential investors or buyers know the value of investing in or purchasing the business.
One drawback to be aware of and why a business may not want to focus on EBITDA is that it ignores asset costs (by eliminating depreciation and interest expenses). This can be misleading to a business owner when making business decisions. One way to overcome this drawback is by reviewing a cash flow statement alongside the EBIDTA computation when analyzing the business.
This blog looked at EBITDA from a bird’s eye view, giving just enough information to help you, as the business owner or executive management team, understand what it is and what it means for your business. If you would like to understand more about EBITDA or have questions, please get in touch with our office or your CPA.
DISCLAIMER: The information provided herein does not constitute the provision of legal advice, tax advice, accounting services, or professional consulting of any kind. The information provided herein should not be used as a substitute for consultation with professional legal, tax, accounting, or other professional advisers. Before making any decision or taking any action, you should consult a professional adviser who has been provided with all pertinent facts relevant to your particular situation and for your particular state(s) of operation.
