EBITDA stands for Earnings Before Interest, Tax, Depreciation, and Amortization: profit before deducting interest expenses, taxes, depreciation, and amortization. You calculate EBITDA by adding interest, taxes, and depreciation back to net income after taxes. EBITDA is widely used in business acquisitions, investments, and financing applications because it allows for effective comparisons between businesses.
Inhoud:
- What is EBITDA?
- Why is EBITDA important?
- What is the relationship between EBITDA and enterprise value?
- How can you calculate EBITDA?
- What is the difference between EBITDA and EBIT?
- What should you keep in mind when performing a valuation using EBITDA?
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1. What is EBITDA?
EBITDA is an acronym for the English term: Earnings Before Interest, Tax, Depreciation, and Amortization (EBITDA). Translated into Dutch: profit before interest, taxes, depreciation, and amortization. It is essentially gross profit including all financial deductions (taxes, interest, and depreciation) and shows how much cash flow a business can generate.
2. Why is EBITDA important?
EBITDA is a profit metric that, in principle, cannot be manipulated, making it a good benchmark for comparing businesses. It accurately reflects a business’s performance because it shows earnings before accounting and financial deductions have been applied.
3. What is the relationship between EBITDA and enterprise value?
EBITDA also provides a good indication of a business’s profitability and, therefore, its value. The formula “EBITDA × multiple” is often used to determine a business’s value; thus, the higher the EBITDA, the higher the business’s value. Although it is an indication of value at a specific point in time, it accurately reflects a business’s financial health.
Moreover, EBITDA in turn affects the amount of the multiple itself. Scientific research has shown that the smaller a company is, the greater the chance that the expected free cash flows will not be realized. Small businesses are simply more volatile and risky.
TIP: The Brookz Takeover Barometer is published every six months and includes the average multiples by sector.
4. How do you calculate EBITDA?
Even without in-depth economic knowledge, it is possible to calculate EBITDA. Net profit after taxes is the basis of the calculation. Below is an example of how to arrive at that net profit from the income statement.
Example:
Net Revenue €1,000
-/- cost of goods sold €350
= Gross margin €650
-/- Depreciation €50
-/- Miscellaneous expenses €200
= Operating income €400
-/- Net interest income and expense €50
= Net profit €350
-/- Taxes €50
= Net income after taxes €300
From this setup, you can then calculate EBITDA fairly easily:
Net Income €300
+ Depreciation/amortization €50
= Cash Flow €350
+ Taxes €50
+ Interest income and expense €50
= EBITDA €450
The formula above includes several terms that may require some additional explanation.
Net income: This is simply a company’s net earnings. On the income statement, net income appears at the bottom of the calculation, as the net result.
Interest Income and Expenses: Interest is listed under profit. This interest depends on various factors, such as the type of business and the industry in which the company operates. In financial statements, you’ll find this expense listed under the category of non-operating expenses. Good to know: Capital-intensive industries often have higher interest expenses on their income statements due to significant direct investments in physical assets. Examples include the aviation industry, the chemical industry, and shipbuilding.
Taxes: Primarily relevant due to varying rates. The tax rate varies from business to business and is also subject to economic influences on an annual basis. On the income statement, you’ll also find this expense item listed under non-operating expenses.
Depreciation & Amortization: We’ll cover these two items together, since they both involve a reduction in value. On the income statement, you’ll find these write-offs listed under operating expenses. Certain capital investments lose value through use, and this must be recorded.
5. What is the difference between EBITDA and EBIT?
Although EBITDA and EBIT are often used interchangeably, they are not the same. EBIT is based on operating income after depreciation and amortization, excluding financial results and taxes. This article on Brookz takes a closer look at the differences between the two terms.
6. What should you keep in mind when performing a valuation using EBITDA?
Regardless of the discussion about valuation with EBITDA, and the widely varying multiples, it is good to remember that rules of thumb are not set in stone. As a buyer, for example, you need to be alert to the fact that rules of thumb do not take into account a specific situation.
Every business is unique. So look beyond the rules of thumb and do thorough research. Assess the business to be bought before you blindly rely on rules of thumb.
Frequently Asked Questions About EBITDA
What exactly does EBITDA mean?
EBITDA stands for Earnings Before Interest, Tax, Depreciation, and Amortization: a business’s profit before interest, taxes, depreciation, and amortization. It is essentially gross profit including all financial deductions and shows how much cash flow a business can generate on its own, independent of financing decisions and accounting depreciation.
How do you calculate EBITDA based on net income?
You add depreciation/amortization, taxes, and interest income and expense back to net income after taxes. In the example, a net income after taxes of €300 results in an EBITDA of €450 (300 + 50 depreciation + 50 taxes + 50 interest).
What is the difference between EBITDA and EBIT?
EBIT is operating income after depreciation and amortization, excluding financial results and taxes. EBITDA goes a step further and adds back depreciation and amortization to the profit. As a result, EBITDA is always at or above the level of EBIT.
Why is the EBITDA multiple lower for smaller businesses?
Scientific research shows that smaller businesses are more likely to fail to achieve their expected free cash flows. Small businesses are more volatile and risky, which buyers interpret as a lower multiple and thus a lower enterprise value for the same EBITDA.
Can you use EBITDA to determine the value of any business?
EBITDA multiplied by a multiple provides a quick indication of a company’s value, but the multiple varies greatly by sector and situation and is not set in stone. Rules of thumb do not take company-specific risks into account, so a buyer should always conduct thorough research before relying solely on a rule of thumb.
