In the world of mergers and acquisitions, we routinely use the acronym EBITDA. Some call it E-BIT-D-A. But most simply say E-bit-dah.
When it comes to selling your company, virtually everyone involved in the transaction will know the term, which is shorthand for Earnings Before Interest, Taxes, Depreciation and Amortisation. I say “virtually” everyone, because sometimes the only people who don’t know what EBITDA means are the business owners looking to sell their companies.
EBITDA is not a calculation that business owners would normally find useful. It’s not something that will show up on their balance sheet. It’s not revenue or expenses. It doesn’t hit their bottom line.
But when it’s time to sell, EBITDA becomes the building block for constructing the market value of a business. It is a number that measures a company’s profitability before deductions (interest, taxes depreciation and amortisation) that are not considered part of the firm’s operating costs. And it’s relatively easy to calculate.
In the M&A world, we frequently say things like “XYZ Company should be valued at seven times EBITDA.” In that context, EBITDA is considered by many as a good way of comparing the valuation of one company versus another, even though it is not a complete view of a company’s financial health.
Yes, EBITDA can be confusing, and it is not without its critics. But it’s important that anyone contemplating the sale of his or her business understand it, because they will see it again and again as they move forward in the sales process.