EBITDA is the figure commonly used to measure a company’s value and how well it performs against other businesses.
EBITDA stand for earnings before interest, tax, depreciation and amortisation and isn’t usually shown separately in formal financial statements. Usually its earnings before interest but after depreciation that’s shown in the formal Income statement.
The reason EBITDA is commonly used as a measure is because depreciation and interest dilutes profit figures. This is due to companies ability to use differing asset lives for depreciation and different financing methods used to fund the company. A company with assets depreciated over a shorter period and with high levels of debt will have fewer profits than a company with longer asset lives and little debt.
So EBITDA measures the actual cash the company generates before taking such expenses into account. This is why it is important and this figure expressed as a percentage of the company revenues, the EBITDA margin, can then be compared to its competitors and others. EBITDA is also used by analysts to compare earnings per share for listed companies.
EBITDA is also used to value a company either for sale or for investors’ taking a share of it. The usual method is to take a multiple of historically achieved EBITDA, say 5 or 6 times depending on the industry sector, the economic climate and future earnings potential. Future earnings will be taken into account if EBITDA is expected to increase significantly in the short-term. The higher the perceived future earnings potential, the higher the EBITDA multiple.
So when you come to sell your company or get investors’ on board, it is important to have a great track record of increasing EBITDA margins to maximise the value and also a good story on future earnings trends. This is what gets investors’ interested. After all they are on board for future profits.
So the key tips for maximising EBITDA are:
1. Focus and monitor EBITDA and margins in your internal financial statements and business plans
2. Compare EBITDA margins of your competitors – the higher your margins the better
3. Don’t add any new business or expand if it reduces your EBITDA margin – unless to gain market share
4. Ensure your accounting records are up to date and monthly management accounts are produced with EBITDA margins highlighted.
Are you following the above to maximise your company value?