Growing Your Business

Understanding EBITDA: How Does It Affect the Value of Your Business?  

Understanding EBITDA: How Does It Affect the Value of Your Business?  

EBITDA, which stands for "earnings before interest, taxes, depreciation, and amortization," is a calculation that can be used to determine a company's enterprise value. This method is most often used for companies in the middle market or lower middle market.

What Does It Tell You?

Your company's EBITDA is an indicator of the business's profitability, as well as its ability to make payments on outstanding debts for a period of one year. It is helpful in calculating Enterprise Value for the purpose of selling a business or acquiring a business.

How Does It Work?

To calculate a company's EBITDA, all you need to do is calculate the company's earnings before they have been reduced by amortization, depreciation, taxes, and interest. You can calculate EBITDA using the data from the last 12 months, or you can use it to make a 12-month projection.

The sample chart from InvestingAnswers below details the basic EBITDA calculation.

Making Adjustments to EBITDA

In some cases, a basic EBITDA calculation gives you a misleading picture of your financial situation. However, you can make adjustments to EBITDA to improve its accuracy. For example, you may need to remove some accounts receivable from the calculation if you failed to collect them, or you may need to reduce the EBITDA to account for older, worn out equipment. You may also increase your EBITDA by adding the value of certain intangible assets, such as your employees. Once you have added and subtracted all of these factors, you will have your "adjusted EBITDA."

Calculating Enterprise Value with EBITDA

You can use EBITDA or adjusted EBITDA to calculate your business's Enterprise Value. To find the Enterprise Value, simply take the EBITDA or adjusted EBITDA and multiply it by the Enterprise Multiple. Your business's Enterprise Multiple depends on several factors, including the overall health of your business, the cost of capital, and the industry in which your business operates.

Calculating the Enterprise Multiple

The Enterprise Multiple itself is a ratio derived from recent sales of comparable businesses within the industry. To calculate the Enterprise Multiple for a given sale, you can divide the sale price by the business's most recent EBITDA. After you have done this for several different comparable business sales, you will have a range of Enterprise Multiples. In calculating your company's Enterprise Value, you can use the high and low multiples to calculate a range of possible Enterprise Values, or you can use the median to calculate a single EBITDA Enterprise Value. 

Enterprise Multiples vary according to industry, with higher multiples found in the industries that grow the fastest. Keep in mind that your enterprise multiple will fluctuate over time. For this reason, it's important to recalculate this multiple every time you want to recalculate your business's Enterprise Value. 

How EBITDA Enterprise Value Differs From Other Valuation Methods

The EBITDA Enterprise Valuation method is different from the method most often used by small business because it isn't based on the Seller's Discretionary Income. Because this valuation method includes the company's debt, it is an ideal choice for estimating value prior to a possible merger or acquisition.

EBITDA Enterprise Valuation factors out business taxes when estimating a business's value. This is beneficial for privately owned businesses that are structured as pass-through entities, which prevents them from paying taxes. This valuation method is ideal for asset-rich companies, such as those in the technology, real estate, manufacturing, distribution, and wholesale industries.

Valuing Your Business

EBITDA Enterprise Valuation isn't the only way to value your business, and it isn't appropriate for every company. However, if used properly, this calculation can give you a good idea of what would happen if you tried to sell your business. This calculation is also useful if you are considering a merger or acquisition.

Calculating and/or understanding EBITDA business valuation can be difficult. For assistance with this type of business valuation, or for other business accounting needs, please contact an accounting expert today.

Frank Jenkins, CPA writes for TaxBuzz, a tax news and advice website. Reach him at [email protected].

share this post
Search for matches...
Frank Jenkins Jr

Frank Jenkins Jr

Frank Jenkins Jr. is the managing partner of Adams, Jenkins & Cheatham, a CPA practice based in Midlothian, VA. Frank specializes in Consulting services, tax planning, accounting, audit & assurances. "I genuinely care about our clients because I have a personal connection with them. This job requires me to multi-task and work under tight deadlines. I get great professional satisfaction from balancing firm and client commitments while building a strong team here at AJC."

ADAMS, JENKINS & CHEATHAM
0 reviews

Virginia

Recommended Professionals

In the face of economic uncertainty, TaxBuzz is the industry's most up-to-date tax information.

Join 60,000 who get our weekly newsletter. No spam.

We know tax and accounting issues are complicated.

Do you have additional questions on this topic for this author?

Related Posts

Latest Posts