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What is EBITDA? Is EBITDA Relevant To A Business Seller? If you are selling a business and have just started learning about it, by now you must realize that EBITDA is a term that is often used as an important number to valuate your business. But, unless you have already sold a business before, you probably don’t know what it means. Better yet, do you know how to calculate it? Today we will understand both of these issues because EBITDA could be a key number to determine how much your business is worth in the marketplace.
What is EBITDA?
First of all, the short. EBITDA is an acronym which stands for Earnings Before Interest, Taxes, Depreciation and Amortization. It is often used to compare the financial strength between two or more different companies. When you compare the profitability between two different companies:
- it becomes interesting to discount interest payments from different financing operations,
- ignore tax to avoid the contrast between different political jurisdictions,
- ignore depreciation of assets to avoid the effect brought by varying collections of assets, and
- amortization originating in different takeover histories.
Issues with EBITDA
There are also issues to consider when choosing EBITDA as a comparison tool. We can “normalize” or “adjust” EBITDA. That means there has been an adjustment to reflect income or expenses. These wouldn’t be present in the future under new ownership. Some examples are a business car that is leased by the company and used by the owner. Or the owner’s salary that is different from a director. Or a manager’s salary as per a fair market value.
EBITDA divides experts as being a good or a bad tool to compare different businesses. In fact, some critics think that EBITDA is far from being a perfect way to do so. The undeniable fact is that buyers, sellers, and business brokers overwhelmingly use EBITDA in the marketplace. All those interested in determining and negotiating business valuations during a merger or the sale of a company.
Why do people use EBITDA as a valuation tool? The issues arise from the aforementioned market players having to measure, as objectively as possible, many moving parts that interact among themselves during the course of business in order to compare different companies and assess their value. Its goal is to generate an accounting measure in dollars and cents, which then simplifies all these parts into a common denominator that works as a proxy for the company’s profitability.
The Problems With EBITDA
EBITDA ignores key factors. The biggest consideration is when EBITDA is directly translated as a measure of the true value of a company during a merger or an acquisition. That does not exist and cannot be accurately measured for any business.
For example, EBITDA ignores what could be interesting factors to consider in a particular business transaction. EBITDA, cash flow, profit, and seller’s discretionary earnings are usually different numbers. Each of them has its own importance when it comes time to assess a business market value.
Since the seller’s expense amounts are irrelevant to the future owner’s new firm, EBITDA omits and ignores interest, taxes, and even non-cash charges. In doing so, it may not account for the need of capital expenditures needed to maintain the business activity or fuel its growth. It is undeniable that EBITDA is a factor widely used by the M&A marketplace during a valuation discussion. However, the buyer needs to plan accordingly for paying all interest, taxes, and non-cash charges. When they start their new operation, after the finalization of the sale transaction. So, keep in mind that EBITDA may help you to compare different companies. However it ignores important elements for the business activity that will continue under new ownership.
Heading Towards The Future
EBITDA is a very useful tool to speed up comparisons between several businesses. Especially in the early stages of a merger or an acquisition. It helps level the ground to allow a simpler value assessment process. However, it leaves out important factors that could fuel or hinder the company’s future growth.
Well-seasoned business brokers, investment bankers, or other professionals with a track record in mergers and acquisitions are aware of these factors. In fact, M&A brokers can quickly see the most important factors in a business valuation. And help with the analysis and negotiation of a Business Sale. They also consider EBITDA and other important figures that will help owners get the most value from their business sale. Thus, EBITDA is Relevant To A Business Seller.