It's All About EBITDA (Duh!)

EBITDA and Valuation

While it’s true that EBITDA first came into common use in the 1980s, when investment bankers were searching for ways to predict whether or not a company had the ability to service its debt, it is useful for all business managers.

It became a tool for assigning a value to a business, especially in deals between companies in different industries. EBITDA can be used to analyze and compare profitability, because it strips away the non-comparables. So, if you want to increase the value of your business (to sell it, for example), focus on increasing the value of your EBITDA.

In the case of an unprofitable company, measuring EBITDA will make it easier to figure out which elements of the business need to be improved. It puts a spotlight on ways to help cash flow, such as improving gross profit margin, lowering the cost of goods sold, or taking expenses out of general and administrative areas, for example.

Historically, public companies focused management decisions on how actions impacted earnings per share. Nowadays, analysts are starting to realize the value of cash flow. In the case of nano-cap, micro-cap, and some small-cap companies that are not yet generating earnings because management is investing in the future of the firm, measuring EBITDA may not be the most appropriate measurement. Other key indicators include whether revenues are growing and gross profit margins are increasing. But it’s still important to track EBITDA and subtract the investment spending to understand if the core business is healthy.

A word of caution: While I am a strong proponent of EBITDA, it’s wise to be aware that EBITDA is a non-GAAP (Generally Accepted Accounting Principle) measure that allows a greater amount of discretion as to what is and is not included in its calculation. Companies can change the items they include from one reporting period to the next. So be sure that you understand those details.

Cash is the life blood of a company, so measuring cash flow is like monitoring your blood pressure. When my firm begins working with troubled companies, the first action item is to analyze EBITDA, and that’s how we know if we need a band-aid, emergency surgery, or something in between.

This may seem simplistic, but my experience is that too many executives and financial managers have been trained to focus on the profit-and-loss statement alone—and think that EBITDA is one of those investment- banking jargon words used to impress co-workers hanging around the water cooler. But in my vision of the perfect business, management would live by the mantra, “Duh, it’s all about EBITDA ,” and avoid becoming an EBITD . . . fool!