EBITDA Simply Explained / What is EBITDA?
EBITDA stands for “Earnings Before Interest, Taxes, Depreciation, and Amortisation.” It is a financial metric that provides a snapshot of a company’s profitability by looking at its operating performance without taking into account certain non-operational expenses. Lenders tend to use this metric a lot when assessing whether a business can afford to borrow, especially when it comes to commercial mortgages. But is this helpful? Probably not, so let’s break it down.
EBITDA – Let’s Break it Down
This refers to the money a company makes from its primary business activities, such as selling products or providing services.
This means that we are considering the financials before adding or subtracting certain items.
This is the cost of borrowing money. By excluding interest, we focus solely on how well the company is performing without taking into account its debt situation.
This represents the income taxes a company has to pay on its profits. Excluding taxes helps us understand the core business profitability without the influence of tax rates.
When a company owns assets like buildings or equipment, their value decreases over time due to wear and tear. Depreciation is an accounting way to spread the cost of these assets over their useful life. By excluding depreciation, we focus on the company’s operations rather than accounting adjustments. Whilst depreciation is an expense it is not a ‘cash’ expense. If you want more info on depreciation, this article is a good read.
Similar to depreciation, amortisation is the process of spreading the cost of intangible assets (like patents or trademarks) over their useful life. By excluding amortisation, we get a clearer view of the company’s operational performance. Like depreciation, amortisation is not a ‘cash’ expense.
Summing it up
In simple terms, EBITDA is a metric used to assess how much money a company is making from its core business operations, disregarding interest payments, taxes, and accounting adjustments like depreciation and amortisation.
It gives lenders a clearer picture of a company’s operating profitability, making it easier to compare performance across different companies or industries. However, it’s important to note that EBITDA does not provide a complete financial picture, and other metrics like net income should also be considered when considering a company’s financial health. This is why lenders like to judge affordability using EBITDA but will then ask follow up questions around different items within the accounts.
These follow up questions will involve things like whether the new finance is replacing previous borrowing, whether there are one off costs and whether the performance now can be expected to repeat in future periods. Remember that lenders are looking for cash rather than profit as it is an ability to generate cash that makes finance affordable, Cash is King? It still applies.
Any questions about how lenders use EBITDA or if you want to know more about financing your business then get in touch.
By Dave Farmer