Pierre Baudis

What is EBITDA? And why is it important?

Across the dizzying array of financial jargon, it’s likely you’ve come across the term EBITDA. But what exactly does EBITDA stand for? And what does it represent for your company?

Throughout this article, we’ll take a look at how you can calculate EBITDA and how it can be used to manage your business’ finances more effectively.

EBITDA allows you to assess your business’ performance. It’s a great indicator of how it’s behaving financially - in its regular activity. That’s because EBITDA is a metric that looks at your businesses profitability before the effects of any debt, government payments/taxes and the decline in value of business assets.

“It’s very simple, it’s basically the gross revenue your company made! It is the result before taking into account financial interests linked to investments.” - Thierry Veil, co-founder of Bagelstein

Why is EBITDA important?

It is important to calculate and track your EBITDA for several reasons : 

  1. To gain insights into your company's cash flow. This allows you to make more educated decisions such as - can I hire more staff? Are my profit margins healthy?

  1. To be able to compare your business’ results to others in the industry.

  1. To provide a good measure of how valuable your business is to banks and potential investors.

  1. To evaluate your company’s ability to take on additional financing or to make an investment.

“Measuring EBITDA regularly allows a business owner to identify how healthy their margin are, if they are correctly staffed, and allows them to track sales and purchases” - Thierry Veil, co-founder of Bagelstein

Remember:

EBITDA is a measure of financial performance and profitability. Therefore, in general, it’s best to keep your EBITDA as high a value as possible. But keep in mind that financial performance benchmarks can vary widely across different sectors and business sizes!

Now, let’s see how you calculate EBITDA.

How to calculate EBITDA?

There are two ways to calculate EBITDA.

One uses operating income as the starting point, and the other uses net income. 

EBITDA using Operating Income:

Your Operating Income is the profit your company has remaining after subtracting the costs of daily business activities.

And as operating income is calculated before you subtract interest and taxes, you only need to add depreciation & amortisation (D&A) back in to calculate EBITDA.

The formula to calculate EBITDA using operating income is : 

EBITDA = operating income + DEPRECIATION + AMORTISATION

EBITDA using Net Income:

Your Net Income is the profit your company has remaining after subtracting your total costs, taxes and interest.

Unlike calculating EBITDA using Operating Income, this method requires you to add back in interest and taxes - as these are not included in the net income calculation. 

The formula to calculate EBITDA using operating income is : 

EBITDA = NET INCOME +INTEREST + TAXES + DEPRECIATION + AMORTISATION

“The trick here is to ensure all your numbers match! Or you’ll end up with irrelevant results for the given period.” - Thierry Veil, co-founder of Bagelstein

What to keep in mind when calculating EBITDA

First of all, don’t confuse EBIT with EBITDA! They are two similar profitability metrics, but they have important differences! As EBITDA doesn’t include depreciation, the results (compared to EBIT) can differ quite drastically, especially for companies with many fixed assets and/or loans.

Also, EBITDA isn’t actually an official accounting metric, and therefore not government regulated. This leaves it open to being ‘window dressed’ by savvy accountants, in order to make financial performance appear stronger.

A business should also use caution when analysing EBITDA. It can be somewhat misleading. Your company may still have expensive assets and loans that can heavily impact your overall financial health. 

Cash flow management and EBITDA

As discussed, EBITDA is able to provide some level of visibility over your cash flow. As a business leader, it’s important to track this in order to guide your strategic choices. For example, will your business have enough cash in the short and long term to make an investment?

Trezy is the real-time financial analytics tool specifically built for business owners. Easy to set up and even easier to use, Trezy will automatically monitor your business’ financial performance through a live connection to your business transactions. 

At the click of a button, you can analyse your cash position today, and make forecasts for future scenarios. Your financial truth is always up-to-date in Trezy, so you can make business decisions with confidence.

Insights from Thierry Veil, co-founder of Bagelstein

How would you describe EBITDA to a young entrepreneur? 

It’s very simple, it’s the gross revenue your company has made! It’s the result before the effects of financial interests linked to investments. You take your revenue and then deduct the costs directly involved in those sales -  so mostly raw materials and wages! It’s good to monitor your EBITDa regularly because it’s a reflection of how healthy your margins are and if you are correctly staffed.

What about a more mature company? 

A more mature company will usually be closely monitoring turnover using accounting software. The problem that can arise is including purchases in your accounting. This is because you will have to gather invoices and bills, in real-time, to do so! The trick here is to ensure your numbers match, or you will end up with inaccurate results for the given period. 

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