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Why EBITDA matters for your business

If you’re running a business, you’ve probably come across the term EBITDA. Understanding this metric can be incredibly useful, providing insights into your company’s operating performance and helping to shape your strategic decisions.

EBITDA: What It Is and Why It Matters for Your Business

EBITDA is an acronym that stands for Earnings Before Interest, Taxes, Depreciation, and Amortization. It zeros in on the earnings from your business’s core operations by leaving out expenses that can vary widely between different companies, such as tax rates and interest expenses. This gives you a cleaner measure of your company’s profitability from its day-to-day activities.

The EBITDA Formula

Calculating EBITDA is simple:

EBITDA = Revenue − Operating Expenses + Interest + Taxes + Depreciation + Amortization

Here’s why EBITDA can be a helpful tool:

  • It allows you to measure the financial performance of your core business operations.
  • It helps in benchmarking and comparing your performance against peers.
  • It can make your business more attractive to investors and lenders by showcasing profitability.

However, EBITDA is not without its flaws. It can sometimes present a distorted picture of a company’s financial well-being. For instance, EBITDA can be inflated by one-off sales, aggressive revenue recognition, or by not accounting for maintenance and other necessary expenses. This could lead to overvalued company assessments and suboptimal strategic decisions.

Listen to the Financial Podcast Episode 37 version of this post here.

How to Use EBITDA Correctly

Here’s how you can make EBITDA work for your business:

  1. Regular Calculations: Keep tabs on your EBITDA to monitor your operational performance and track improvements or declines.
  2. Strategic Planning: Base your investment decisions and cost management strategies on insights from EBITDA.
  3. Comprehensive Analysis: Pair EBITDA with other financial metrics for a well-rounded view of your company’s financial state.

Making Sense of the Numbers

Calculating EBITDA means gathering specific financial data:

  • Revenue: The total income from sales.
  • Operating Expenses: Costs that keep the day-to-day business running.
  • Interest Expense: The cost of any debt.
  • Taxes: Corporate income tax paid.
  • Depreciation and Amortization: Reflecting the decreasing value of tangible and intangible assets, respectively.

You can find these numbers in your financial statements. If you use accounting software, it might even calculate EBITDA for you. Otherwise, you’ll find the necessary details in your income statement and cash flow statement.

Where to Find the Data:

  • Income Statement (Profit and Loss Statement): This financial document provides a detailed account of your revenue, operating expenses, and, in most cases, interest expense and taxes over a specific period. It’s the primary source for most of the data you need.
  • Cash Flow Statement: This statement can offer insights into depreciation and amortization expenses, especially if they’re not explicitly detailed in the income statement.
  • Accounting Software: If your business uses accounting software, you can easily find all these figures categorized in the financial reports section. Most modern software will even calculate EBITDA for you, or at least provide you with the numbers needed to do it yourself.
  • Financial Records: For businesses that don’t use software, your bookkeeping records or financial ledgers should have all the information you need. It might require a bit more effort to compile, but it’s all there.

Monitoring your business KPIs

EBITDA is a useful gauge of your business’s operational profit-making ability. When used wisely, it can inform your strategic decision-making and help attract investment. Just remember to consider EBITDA as part of a broader financial analysis to ensure you have the full picture of your company’s financial health.

There are many other KPI metrics to consider, like margin, inventory turnover rate, current ratio, debt to assets, and more! Want to discuss your business KPIs and how to know if your business is financially healthy? Click here to schedule you free consultation.

Are you a business owner and/or business leader? Click here for additional resources.

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Author: Dale Shafer II, CFP®, APMA®, CDFA®

The National Association of Personal Financial Advisors
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