At Viking Mergers & Acquisitions, we consistently express to our clients that performing a valuation of their business is the first step in planning a successful exit strategy. Business valuations include many moving parts, and understanding specific components of the process can give an entrepreneur an idea of what their business is worth.
What Is EBITDA? What Is It Used For?
EBITDA is a primary indicator used in determining an accurate and realistic valuation, and it stands for Earnings Before Interest, Taxes, Depreciation, and Amortization. This measure is one of the indicators our firm uses to calculate the value of a business and its future financial performance and earning potential.
What is Amortization in EBITDA?
While the “EBITD” part of the formula is familiar to most business owners, the “A” gives many people pause. Since the question is so common, we will begin by answering “What is Amortization in EBITDA?” and work our way back to the formula as a whole.
In EBITDA, Amortization refers to expensing intangible assets.
Intangible assets are non-physical assets; examples include goodwill, copyrights, patents, trade names, customer lists, contracts, and franchise agreements. Intangible assets are typically complex compared to fixed assets, but they are included on a company’s balance sheet and have a multi-period useful life.
How Do You Calculate EBITDA?
As we mentioned above, EBITDA is net income with the addition of any interest, taxes, depreciation, and amortization. An EBITDA analysis helps calculate the business’s cash flow and is essential when comparing similar companies within a single industry during the valuation process.
We covered the most common question (what is amortization in EBITDA) above, so let’s consider the complete formula for an EBITDA calculation:
Interest expense is found on a company’s income statement or profit and loss statement and is added back in our valuations. Interest is a non-operating expense and will differ between individuals. The interest expense line item can consist of interest from loans, lines of credit, or other forms of debt. To perform an accurate valuation, we always ask business owners to provide us with appropriate financial statements that include interest expenses. These statements include the last two years of federal tax returns, two years of Profit & Loss Statements (P&L) including balance sheet, and interim financials.
At Viking, we use the net income on the first page of the tax return and only add back items that have been expensed from that net income, e.g. the expenses listed on the first page and expenses on the Other Deductions Statement. This means the tax portion of EBITDA rarely comes into play in our valuations; however, when looking at a P&L, estimated tax payments to the State or Federal Government will be part of EBITDA.
Understanding depreciation begins with recognizing the importance of fixed assets. Fixed assets are tangible assets, meaning that they have a physical form and can be touched. Tangible assets include equipment, machinery, land, etc. Depreciation involves expensing a fixed asset over its useful life. Useful life is the predicted lifespan of a depreciable fixed asset. Depreciation is a non-cash expense that restores the cost of a fixed asset.
Here, we come back to amortization. Recall that amortization in EBITDA involves expensing intangible assets (rather than tangible assets) over their useful life.
Calculating EBITDA involves reviewing a business’s income statement, and we can express this in two ways:
- EBITDA = Earnings + Interest + Taxes + Depreciation + Amortization
- EBITDA = Operating Profit + Depreciation + Amortization
Both calculations arrive at EBITDA.
Business valuations are our specialty here at Viking M&A. Determining the value of a business is the first step in preparing for its future. Our intermediaries and analysts have immense experience in calculating a business’s value based on cash flow and comparable statistics. If you are thinking about selling your business, contact us today for a no-cost, no-obligation valuation. Viking can help you prepare for your future and explain the valuation and sales processes professionally and confidentially.