Sometimes there is confusion about what is EBITDA or earnings before interest taxes depreciation and amortization. Small business owners also want to know why is an EBITDA multiple important in a company valuation?
My name is Melissa Gragg and I am a company valuation expert in St. Louis Missouri.
Let's start with explaining what EBITDA really is and then we will understand how it's important in determining the value of a company. Many people are familiar with the term EBITDA, a business owner just may not understand the EBITDA calculation.
First, you need to start with your earnings, which could also be called net income, income after taxes, profits, profits after taxes. You get the idea, it's basically what you have left over from your company revenues after you take out all of the expenses.
Now you want to start to add back some items such as interest on loans or debt and corporate taxes. You also want to add back depreciation and amortization which are basically non-cash expenses.
Now you have determined an earnings level which you can compare to other companies in your industry.
The point of EBITDA is to eliminate the factors a business owner has discretion over, such as the type of debt financing and capital structure, whether it's taxed as an S-corp or C-corp and if the assets are depreciated using acceleration methods such as Sect 179 depreciation.
Once you eliminate some of these items then you can look at you company's EBITDA level and compare it to an EBITDA multiple derived from industry transactions, mergers and acquisitions or industry reports.
In the valuation of the company there are many methods to consider and one of them is the market approach. This is the approach that uses various market multiples, basically what companies have sold for in the open market, to determine the value of company and one of them is a multiple of EBITDA.
For example, there may be consolidation in your industry and private equity groups or large industry players may pay 6 to 7 times EBITDA. This means that the value of the company would be in the range of six to seven times the EBITDA number.
Of course it's not that simple, because a buyer would have to consider many factors in order to determine what they would pay for particular company but it does give the business owner an idea of the range of value.
Buyers will also look at adjusted EBITDA, which is calculated by reviewing the financial statements in determining if there are owners discretionary items such as higher salaries for management, perquisites such as cars and any other nonoperating items, such as vacation home expenses or nonrecurring income or expenses such as loss from a fire or income from the sale of an asset.
Basically a buyer would look to normalize EBITDA for all of the expenses and/or income, which may not continue into the future.
This is why it's not only important to understand what the market multiples or EBITDA multiples are in your industry but also to understand what does your EBITDA look like for this year, in the past and going forward.
If you'd like to know more about how to value a company, or if you are selling a business and have some questions about the value give us a call at 314-541-8163 or email us at Melissa@bridgevaluation.com