As a business owner, you need to know how well your business is doing financially. It’s essential not only for your own peace of mind, but to reassure investors, inform strategic decisions, and help you access loans or investment.
There are a few ways you can measure your performance — you’re probably used to measures like revenue, gross profit or operating profit. But have you measured EBITDA?
While it’s not something you would find in all financial reports — and many people aren’t as familiar with it as they are with other metrics — EBITDA is a useful way of measuring your business’s profitability.
Here’s what you need to know about it, and why you might choose to use it.
What is EBITDA?
EBITDA stands for earnings before interest, taxes, depreciation, and amortisation.
It’s a way of looking at the cash a company generates in a way that’s directly related to its operations — rather than including factors that might not be relevant to its core performance.
Let’s look at the different elements of EBITDA in more detail.
This is usually your net profit (the total revenue you’ve generated from sales minus the total amount you deduct as a business cost).
Interest and taxes
While the interest you pay on any debts and the tax you pay to the Government are both important factors to your overall financial picture, neither of these are directly tied to how well your business’s operations are going.
They could both be affected by circumstances beyond your control, such as new Government policies or changes to national interest rates.
For this reason, these factors are not deducted from your earnings to reach your EBITDA figure.
Depreciation and amortisation
Once you’ve taken your earnings and added interest and taxes back in, you’ll have your EBIT — also known as operating profit.
But the other factors left to consider are depreciation and amortisation.
Under most businesses’ accounting processes, the cost of an asset is spread out over its ‘useful life’. Tangible assets like equipment or machinery will gradually decrease in value over time (depreciation), while intangible assets like patents or copyright will eventually expire (amortisation), so these costs are generally factored into the business’s finances.
If you’re just trying to get a clear idea of a business’s operational performance, though, these can seem more like quirks of accounting processes than relevant financial information. So, with EBITDA, you add the costs of depreciation and amortisation back in.
Advantages of EBITDA
The main benefit of EBITDA is that it strips back extraneous factors to focus on how well a business is performing in its day-to-day operations.
This can be helpful if you or a stakeholder want to see the business’s potential to be profitable and the cash it can generate, looking beyond any short-term or external problems, and without the effects of different accounting and financial decisions.
It makes it easier to compare your company’s performance to its peers, with other factors removed from the equation.
Disadvantages of EBITDA
Interest, tax, depreciation and amortisation might not be directly linked to your operational performance, but they’re still important factors.
In fact, for certain businesses — such as those with high levels of debt — using EBITDA might disguise significant financial problems or weaknesses.
For this reason, it’s best to use EBITDA only alongside other financial metrics, to better inform your understanding of your financial position — not to obscure underlying issues.
At Spark, we often include EBITDA as part of a wider financial overview for our clients. We think it’s a useful metric for agencies to understand their performance, but we know it’s not always widely understood.
If you’ve got any questions about EBITDA or other financial measures, we’re happy to help out — get in touch to talk about your business’s performance.