Business Valuation Blog | Understanding Buying / Selling a Company

What is EBITDA? How does it impact your company's finances?

Posted by Business Valuation Specialists LLC on Dec 20, 2017 3:08:00 PM

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When you're trying to figure out your company's finances, there are a wide range of formulas and techniques that are available. But which one will work for your company and how will the different options impact your bottom line? One option is looking at earnings before interest, taxes, depreciation and amortization (EBITDA). But exactly what is EBITDA? Here's a look at how this type of value is calculated, what it means to your company and how it can affect your bottom line.

What is EBITDA? How does it impact your company's finances?

So exactly how is EBITDA broken down? Let's take a look:

  • Earnings: This refers to net profit, or the amount of money your company is bringing in minus expenses and overhead.
  • Before: This one's as simple as it sounds - it's the earnings before everything else is taken away.
  • Interest: Interest is typically the figure listed on your company's income statement. It represents the cost of interest on loans and similar financial instruments for that period.
  • Taxes: Taxes are also taken from a company's income statement, making it easy to work them into the figure. This refers specifically to income taxes only.
  • Depreciation: Depreciation refers to how much value an asset has lost over a particular time period. It may be determined using a depreciation table or schedule, or using an equipment valuation to determine change in value.
  • Amortization: Amortization is the expense of a loan, typically in terms of the amount of the loan that has been paid over the year, representing a gain in an asset's value to the company and a lowering of debt.

In general, EBITDA is a great way to determine a company's profitability, but not necessarily its cash flow. This is because it does not actually represent cash earnings, but looks at a wide range of other factors that may come into play with a company's finances. Because it is not a generally accepted accounting principle measure, there is greater leniency with regards to what exactly is included in the statement. It was originally developed to determine a business' ability to service debt. As time rolled on, it became more common when industries had expensive assets that were used for long periods of time. Since that time, it's become a commonplace calculation in virtually every available industry, including the tech industry.

Another report that provides the same basic information is the earnings before income and taxes, or EBIT. The only difference between these two is whether the depreciation and amortization are included in the calculation. When they are excluded from the report, it doesn't mean that they're not being counted, because earnings in this situation refers instead to the company's operating profit.

What is EBITDA? Now that you have a better idea about how this income can be calculated, it's much easier to gain an understanding of how your company operates and its overall financial health. Another aspect of that understanding is the insights you can gain from a business valuation. Business valuations not only provide you with the value of your company, they also deliver information on the market, the industry, your competition and where your company is strong and where it is weak. Why not look at having one performed to see where your company can go from here?

Tags: Business Valuation, EBITDA

How do Big Business Valuation Multiples Work in the Real World?

Posted by Business Valuation Specialists LLC on Feb 1, 2017 2:02:00 PM

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When you're trying to get a grasp on the world of business appraisals, one term that is often tossed around is valuation multiples. In general, it involves business valuations based on the value of another business, either by similar size and market share or by income, which is then adjusted for any differences between the two businesses. But what about valuation multiples we hear about in the news for different businesses? What makes these businesses gain or lose value and how can you apply that information and insight into your own business? Here are a few real-world examples, courtesy of Market Realist, of how companies' valuation multiples actually work.

 

How do Valuation Multiples Work in the Real World?

Fiat Chrysler Automobiles

There are a number of different valuation multiples used in the automotive industry, but one that stands out with Fiat Chrysler is EV-to-EBITDA, or enterprise value to earnings before interest, tax, depreciation and amortization. Recent figures have shown it to be approximately 1.3x, which is half that of Ford's 2.6x and GM's 2.5x. Chrysler's figures are also lower in price to earnings and net profitability. Why? Some of it is related to perceived loss of value in their products, but the main factors include their progress on the company's debt reduction plan, expanding margins consistently and trends in domestic car sales.

Home Depot

Because Home Depot has high earnings visibility, analyzing the price to earnings valuation multiple is one of the easiest ways to look at how this company competes. Even though the housing market is still recovering, the recent slowdown in the economy and uncertainty about changes in the interest rate have lowered the company's multiple from 20.4x prior to announcing its earnings to 18.4x. At the same time, investors are still confident in the company's ability to perform, with even its lowered multiple significantly outperforming competitor Lowe's 15.6x.

McDonald's Restaurants

After McDonald's reported gains in the prior quarter, the company's multiples grew from 18.6x to 18.8x. Though this seems like a small change, it can represent millions of dollars of value that was quickly added to a company that is already mature and does not have as much room for growth as younger competitors. In other words, because McDonald's has already grown through so much of the market, its ability to grow is limited, but their value can still improve based on improved earnings.

Time Warner Media

Time Warner has a price to earnings multiple that is second only to Disney's numbers, and an EV-to-EBITDA multiple that is the highest among the industry giants. But what is their advantage that keeps the company with the high numbers? The company has continued developing original programs, is looking at a new approach to content licensing strategies in overseas markets and has made active gains in promoting its digital platform viewer numbers. These innovations have allowed the industry giant to expand even in a tight market.

As you can see, valuation multiples are a tool used to determine the valuation of a company across many industries and specialties. By knowing how they interact with real work situations, you can get a better grasp of what events will impact your business' overall value.

And of course things change quickly...so by the time you are reading this the company's earnings and possibly the earnings have changed!

Tags: Valuation Multiples, discretionary earnings, EBITDA

Ways to Determine How Much is a Construction Company Worth

Posted by Business Valuation Specialists LLC on Dec 21, 2016 10:37:00 AM

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Whether you want to buy or sell a construction company, you need to know how much the company is truly worth. There are many methods for doing business appraisals, and not all are right for taking the value of a construction firm. Learn which methods to use and which to avoid when figuring out, "how much is a construction company worth?"

Market-Based Approaches to Construction Business Valuations

For an active construction company, a market approach is useful to demonstrate the construction firm's fair market value and position vis-a-vis competitors. An appraiser might use the "Guideline Company Transactions Method," reviewing sales transaction data for other construction firms in similar locations. By comparing the value of these companies on the market, an appraiser can estimate how much the construction company could command in a sale. 

If the construction company is small -- say, a family-owned firm with fewer than 10 employees -- the Multiple of Discretionary Earnings Method is a good choice. When taking the valuation of a company using this method, an appraiser will adjust the company's earnings, then divide the value of transactions by the discretionary earnings. By taking the multiple of the resulting number, a fair market value can be determined. 

An income perspective can be useful to value construction companies of all sizes, and is particularly effective for construction firms that operate from lines of credit, as many general contractors do. With the Discounted Cash Flow method, an appraiser can gauge future revenue five years down the road, then discount this to determine the present value and approximate a fair sale price. 

Capitalization using EBITDA (which stands for earnings before interest, taxes, depreciation, and amortization) can take a single point-in-time value for the company using its cash flow. This method can work for construction companies, but will be most accurate for those construction firms that have a steady cash flow and have demonstrated consistent, steady growth. 

Approaches to Avoid When Taking the Value of a Construction Company 

While construction firms do tend to have a lot of expensive equipment that is valuable, an asset-based approach to the valuation of a company does not factor intangibles. The firm is only as good as its staff members, contacts, and customer base. If a company is sold, will the existing customers and employers be loyal to the new owner? Since hiring and training new employers, or recruiting new customers, would represent a significant challenge to the business value as represented by asset ownership, this method is not a good choice for construction companies.

Especially for construction companies, the intangible, human values for employee skill and employer reputation affect business worth. A reputable business appraiser should be able to select a business valuation method that factors in these intangible assets to reflect the real value of the construction company.

Business appraisers often take a few valuations using different methods, then compare the values they determine to arrive at a fair value of the company that reflects its tangible and intangible assets, liabilities, income, and position in the market. Any appraiser taking the valuation of a company should be able to clearly explain which methods they used, why they used them, and what the data means, then answer any questions you have have before you proceed with the purchase or sale of a construction company. 

Tags: EBITDA, valuing a construction company, how much is a construction company worth

What is my business worth? The answer may surprise you

Posted by Business Valuation Specialists LLC on Mar 1, 2016 1:01:00 PM

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As a business owner, it's easy to assume that the valuation of a company is based solely on the balance sheet or the sum of your assets instead of taking into consideration market conditions and future income. When this happens during a negotiation, it can dramatically impact how much you get out of the deal. Before you assume you know the answer to the question, "What is my business worth", take a look at what company valuation specialists look at when performing business appraisals.

What is my business worth? The answer may surprise you

Asset-Based Approach

An asset-based calculation of business value is one of the most commonly used methods by business owners, but it's also the least accurate. Many business owners will look at the depreciated value of their assets on a balance sheet as compared to their liabilities and think their business is worth the difference. Unfortunately, many businesses depreciate their capital equipment based on a standardized rate schedule developed by the IRS instead of basing the value on what the equipment is actually worth. This can create a significant difference between what a business is worth on paper versus in reality.  First, appraisals should be completed on the assets for the analysis to be accurate.  Second, if the business is profitable, more likely than not the business has created goodwill and this method does not take it into account.

Income-Based Approach

By comparison, a business appraiser will look at one of two other approaches long before they look at an asset-based approach. The first of these is an income-based approach, which calculates the value of a business based on prospective future earnings. The business value is based on a projection of income for a certain time period, which is then discounted for a business value. When a company demonstrates that it has regular growth and cash flow, the appraiser will use a capitalization of earnings method to project potential income into the future. If the company has had irregular cash flow and periods of boom and bust cycles, a discounted earnings method is used to project the income into the future, providing a current price for the expected future benefits.

Market-Based Approach

The other approach that a business appraiser may choose to take, based on the circumstances, is to look at what similar companies are selling for to determine a fair value for a business. This can be based on information available for transactions that occurred for similar businesses. For example, discretionary earnings is calculated by adjusting financial statements to calculate an adjusted EBITDA which includes the owner's compensation, which is then calculated with a multiple to determine value. Other methods look at a percentage of the company's revenue.  Statistics is used to develop multiples and percentages and they are applied to the subject business.

Now that you have a better idea of what a business appraisal specialist sees when performing  valuations, what answer do you want to the question, "What is my business worth?" By having a quality company appraisal performed by a certified business valuation specialist, you can ensure that when you leave the negotiating table, you've done everything you can to ensure you get what your business is really worth.

Tags: what is my business worth, discretionary earnings, EBITDA

What is EBITDA in business valuations?

Posted by Business Valuation Specialists LLC on Feb 2, 2016 9:30:00 AM

EBITDA

If you are having a company valuation done, then the term EBITDA will come up at some point during the appraisal. EBITDA is one of the many factors that an appraiser looks at when it comes to how to determine the value of a company. Learn what this acronym really means and how it affects your company's value now to better understand the appraisal report. 

What is EBITDA?

EBITDA refers to earnings before interest, taxes, depreciation, and amortization. Appraisers use this term as shorthand to refer to the basic business profitability before these other elements are taken out. Since EBITDA looks at just earnings, it gives appraisers a quick way to tell the financial health of the business during a business valuation. EBITDA does not represent the real cash value of the business, but it can help the appraiser determine what amount of debt the business is carrying and how easily the business can pay this off. 

EBITDA is not the only indicator of your company's value - and, on its own, it is not a very useful figure. Once an appraiser has calculated your company's EBITDA, they account for depreciation and amortization to get a more accurate picture of your business's cash flow. 

Once all these calculations have been made, an appraiser has a representation of your company valuation in terms of multiples of EBITDA. In business appraisals, the appraiser might say that your company has a worth or value of "5 times EBITDA" if your company is worth $5,000,000 and your EBITDA is $1,000,000.

The stronger your financial health, growth estimates, and market dominance, the more attractive it is to potential buyers thus multiples are typically driven higher. For this reason, it can be helpful to get an understanding of your EBITDA if you anticipate selling your business down the road. By making business adjustments that improve your EBITDA, you can improve your company's financial health and command a better selling price when you are ready to sell.  

Considerations for using EBITDA

While you can calculate EBITDA yourself, taking proper adjustments is tricky. A business appraiser knows how to work with EBITDA to account for intangible variables. An appraiser can also make sure that one-time expenses and other items are accounted for properly. For example, acceptable tax practices, like writing off one-time repairs, can actually hurt EBITDA. These are not calculations the average business owner can make on their own. 

Since EBITDA calculations and adjustments can be confusing, it is a good idea to work with a business appraiser to calculate the value of a company. Too often, business owners can incorrectly apply a concept like EBITDA and end up with an incomplete value of the company as a result. In a worst case scenario, this could affect the business sales price by causing an owner to accept a lowball offer or sabotage a deal if the owner thinks the business is worth more than it really is. Proceed with a business deal with confidence by hiring an appraiser to determine EBITDA as part of a business appraisal. 

Tags: business valuations, EBITDA