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The acronym EBITDA stands for Earnings Before Interest, Taxes, Depreciation, and Amortization. During the process of a merger or acquisition, intermediaries and investment bankers often use the term “EBITDA” when discussing the value of a business. While EBITDA is not utilized on official statements, the EBITDA is critical to investors as well as business buyers when determining the value of a company and in negotiating an M&A deal.
M&A intermediaries measure the value of a business with EBITDA because it calculates—in the most elemental form—the money that is generated from the sale of goods or services. EBITDA exemplifies the fair market value of the business without factors that are apt to change when the business is restructured by new management. Valuation methods using multiples of EBITDA are also advantageous for comparing companies across different industries, where taxes or leverage may affect cash flow.
While similar, the definitions of SDE (Seller’s Discretionary Earnings) and SDCF (Seller’s Discretionary Cash Flow) are fundamentally different than the mechanics of EBITDA. The terms SDE and SDCF are utilized most frequently by business brokers; however, these measurements do not cover the full scope of earnings in the same manner in which EBITDA calculates value. Business brokers that multiply SDE or SDCF typically add back all depreciation as well as the salary of the business owner. Alternatively, an M&A intermediary utilizing EBITDA makes adjustments for normal expenditures such as machinery and equipment. SDE and CDCF are not necessarily a standardized measurement of a company’s true earnings because these add-backs are chosen at the valuator’s discretion.
EBITDA multiples exclude factors such as taxes and stocks in order to evaluate a company’s worth within its industry. Since taxes and debt values vary from industry-to-industry, business-to-business, EBITDA multiples allow for fair comparisons. EBITDA allows investors and buyers to compare diverse companies across markets because it removes elements that affect certain businesses in varying manners; therefore, rendering some with a lower net income rate that does not correctly display the business’s substance. Since differently managed companies retain different capital structures, it is challenging to compare companies consistently without utilizing EBITDA.
The value of EBITDA lies within its ability to measure a company’s financial health without taking into account outside effects on earnings. Business buyers value EBITDA because it demonstrates the business’s operating performance without managerial factors such as interest payments or extraneous expenses. Buyers want to understand what the bone structure of a business will look like once the owner is no longer an operative element. EBITDA takes into account such factors as excess owner compensation and non-recurring expenses that have the ability to change once under new management.
While most businesses are appraised through some multiple of earnings, it is critical to identify exactly what is being multiplied—especially when using an industry formula. SDC and SDCF generally carry a lower multiple than would EBITDA, so it is important to pay attention to the manner in which a broker or investment banker arrives at a valuation figure. EBITDA provides a framework for valuation judgments in order to create a more cohesive measurement of a business’s value.
If you would like a professional and confidential evaluation of your business, please contact George & Company. We are your expert business appraisers and would be happy to assist you in utilizing EBITDA to value your company.