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The profitability of your company can be evaluated in several ways, but most investors start with calculating Earnings Before Interest, Taxes, Depreciation and Amortization (EBITDA). The investment banking team at Doeren Mayhew Capital Advisors shares insight into understanding EBITDA, key ratios used by investors and lenders, and ways to adjust your calculation before entering the merger and acquisition (M&A) market.
EBITDA is widely used to measure the profitability of a company, especially throughout the M&A process and by lenders. Investors want to know the historical profitability of your business, and EBIDTA helps them assess how much money your company is making before interest, taxes, depreciation and amortization is applied. It can also be used to analyze and compare profitability between similar companies and within your industry, because it eliminates the effects of financing and accounting decisions. EBITDA is calculated by using the following formula:
EBITDA = Operating Income + Interest + Taxes + Depreciation + Amortization
Consider this example:
TTM EBITDA is used to trend how a business is performing without the effects of seasonality and on an annual basis.
While EBITDA offers insight into the profitability of a company, it alone is never the sole factor in an investment decision. The most common ratios used with EBITDA include:
For example, a buyer may identify five publicly traded companies that are very similar to your business model and use those industry multiples to evaluate your TEV. If your industry multiple is six, then your business is worth six times its EBITDA. Investors also look at size premiums on these multiples of EBITDA to plan for an eventual exit.
Financial statements of small and mid-sized businesses often misrepresent a company’s profitability because of various owner expenses used to reduce income and minimize taxes. Before entering the M&A market, consider working with an investment banking advisor like those at Doeren Mayhew Capital Advisors to help “normalize” or adjust your EBITDA calculation. Typical EBITDA adjustments include:
An owner’s salary may also serve as a benchmark for post-sale earnings. For example, if your business is worth six times its EBITDA, then you may want to be conservative with your owner salary if you anticipate only staying with the company for one to two years post-transaction.
The example below illustrates the impact of earnings adjustments to an EBITDA calculation:
As the example demonstrates, normalizing your financial statements eliminates discretionary, nonrecurring and unusual items, and helps increase your business value.
For more information on calculating EBIDTA and how to prepare your business for sale before entering the M&A market, contact our M&A advisors today.
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