Understanding small business valuation is important for both sellers and buyers for good reasons. Sellers want to fully understand how much their business is worth and what is a fair deal to get from selling the business. Buyers, on the other hand, should have a good understanding of how small business valuation works so they can accurately appraise if an opportunity is worth pursuing. When you work with a small business brokerage like Atlantic Business Brokerage, Inc., you will have a knowledgeable broker guide you through the terms and processes that come up within a business purchase. Today, let’s explore what EBITDA is, and the role it plays in small business valuation.
What Does EBITDA Mean?
EBITDA stands for “earnings before interest, taxes, depreciation, and amortization.” This metric evaluates a company’s operating income, and therefore it is a measure for business performance. In general, EBITDA estimates a business’s operating decisions that produce overall profits before taking into account the expenses for things like capital structure (the company’s debt and equity) and depreciation of assets. Note: Income is considered the total revenue earned, and profit is the amount left over after expenses are paid.
Breaking It Down
When calculating EBITDA for small business valuation, interest expenses are excluded because it varies depending on the company’s financing structure. Businesses borrow money to fund business activities, so repayment of those funds incurs interest. By ignoring the expenditure to repay those interests, it’s easier to evaluate the performance of companies by ignoring this payment variable.
Taxes also vary depending on several factors, but this expense goes toward the government. Because tax rules dictate how much must get paid, analysts add this amount back into the EBITDA since it’s not a reflection of business performance.
Depreciation and amortization both refer to the lost value of company assets, both the tangible and the intangible, over time. These values vary mainly due to different calculation methods and assumptions of value, so not accounting for them gives a more precise figure for operating income.
How To Use It
Sellers will push for a premium that is a multiple of their small business’s EBITDA value. Consequently, buyers will try to argue for a lower valuation, which they believe more accurately reflects the business’s value, such as an average of the EBITDA value from the past few years. There are many ways to manipulate the EBITDA value by making changes to the small business. Some methods include cutting costs, reaching new markets, and earning more from sales revenue.
Work With Atlantic Business Brokerage, Inc.
At Atlantic Business Brokerage, our mission is quite simple; we help sellers sell businesses, and buyers buy businesses! Over the past 30 years, ABBI has facilitated the sale of countless commercial properties, businesses, and franchised locations. With our unparalleled knowledge of the business purchase and sale industry and our network of contacts, we offer services to both buyers and sellers that no other brokerage firm can match.