What Is EBITDA & Why Does It Matter For A Business Sale?

These days, there are so many hoops to jump through when selling a business. Investors spare no expense in doing their due diligence and prospective business ventures. One aspect they’ll often look to is EBITDA. Earnings before interest, taxes, depreciation, and amortisation (EBITDA) is a method created to measure the profitability of a business's net income. Using this data, EBITDA offers an accurate method to give an indication of your business's operating performance. For the sale of a business, EBITDA can be used as a means of determining that business's market value.

As someone selling, knowing how EBITDA works and how you can utilise it to get the best value for your business is invaluable. Getting in contact with a broker, like the people at Lloyds Brokers can help business owners get what their businesses are worth. However, this guide will give you the basics of how EBITDA works and why it’s essential for your business sales.

What is EBITDA?

In essence, EBITDA provides a measurement of a business's profits after excluding aspects that the business is unable to control. This includes interest on loans, taxes, amortisation, and depreciation. Many people assume that EBITDA is a method of measuring your company's overall profit. 

However, this isn’t its primary goal. Where profits are calculated by subtracting expenses from your total income, EBITDA leaves out expenses that aren’t in the business's control and measures your profits from there. 

Why does EBITDA matter when selling a business?

When it comes to selling a business, investors and potential buyers are meticulous in looking at different business metrics. They want to see if there’s money to be made with your business, so they’ll turn over every stone to see if there’s a return on investment from buying your company. 

EBITDA gives potential buyers a good idea of the health of your business; that’s why it’s so important. Most investors want to see the business's profitability and cash flow, and EBITDA gives them a good picture of this. Here are a few helpful things to know:

•  Your income statement includes the interest payments from your business loans. High-interest rates mean you're paying more in interest, which lowers your profits, as shown in your financial records. 

• Investors prefer to review your finances without considering the interest payments because interest rates can vary. 

• A new owner might pay off the existing loans or switch to one with a lower interest rate. Thus, they’re interested in seeing your financial situation without the interest payments.

Taxes also change with the business finances or with a different tax strategy, so these aren’t things investors or potential buyers want to see. They want to see what your profits are, excluding these additional expenses. This will give them a more accurate perspective of the income the business is actually generating. 

What are multipliers?

To calculate the value of your business, EBITDA is multiplied by an industry multiplier. This helps investors evaluate the business against others in the same or a similar industry. So, to work out your business's value, the investor will take the EBITDA and times it against the industry multiplier. This will give them an idea of what your business is worth. For example, if your EBITDA is worth $70k and the industry multiple is 5, then your business will be valued at $ 350,000. 

How to Calculate EBITDA? 

To calculate your EBITDA, use the following formula: Net profit + Interest + Taxes + Depreciation and Amortization. Imagine a company with the following financial details for a year:

• Net Income: $200,000

• Interest: $30,000

• Taxes: $50,000

• Depreciation: $20,000

• Amortisation: $10,000

So start with the Net Income and then add the Interest, Taxes, Depreciation, and Amortization since EBITDA excludes these items to focus purely on operational performance.

Here’s an example:

EBITDA - $200,000 + $30,000 + $50,000 + $20,000 + $10,000= $310,000

So, the EBITDA for this company is $310,000. This calculation shows the money the business made from its operations without the influence of financing decisions, taxes, and non-cash accounting items like depreciation and amortisation.

Tips for Improving your EBITDA

For business owners trying to sell their businesses, having a higher EBITDA is essential. Not only will it make their business valuable, but it’ll also attract more potential buyers and investors, encouraging a better sale in the end. Here are some tips to improve your EBITDA:

• Try to reduce your expenses. The lower your expenses are, the higher your EBITDA will be

• Increase your revenue stream. By signing on clients to retainers or contracts, you can increase your revenue stream, which represents better your financial statement and impacts your EBITDA by making it higher

• Move more inventory. Businesses that hold onto inventory have higher expenses because they haven’t earned back the money they used to buy the inventory. Moving this inventory will put money back into your business and increase your EBITDA

• Chat with your accountant or financial advisor and ask them to help you create a strategy to improve your EBITDA in advance so that you’re ready when it's time to sell

Final Thoughts

While EBITDA is only one aspect investors and potential buyers will review when checking your business, it’s still a vital factor that could be the difference between fetching a higher or lower price for your business. We hope this EBITDA guide has given you the information you need to plan effectively for your business sales, and we wish you all the best. Cheers.