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?

Topics: EBITDA, Business Valuation