EBITDA is a six letter acronym, bandied about during contemplation and negotiation of purchases and mergers.
EBITDA stands for Earnings Before Interest, Taxes, Depreciation, Amortization.
EBITDA is often the gold standard by which interested parties determine how successful a company is and if it is a good buy or a good candidate for merging. Certainly, it’s easier to crunch the numbers to come up with an EBITDA figure then wade through dense financial statements.
EBITDA is a good measure of certain aspects of a business, but it is not the complete picture.
EBITDA is helpful in determining:
- Cash flow
- Balance sheets (a good companion to EBIDTA)
- What the company will owe in the short term
- The condition of the assets of the company
- A ballpark figure for valuation of the company (with the caveats listed below).
EBITDA does not take into account:
- What will be required in terms of capital investment to maintain the current and future growth of the company
- The complicated tax picture which varies wildly by the type of business
- Costs of integrating two companies
- The amount of leveraging within the company, which can magnify losses into intolerable levels
- The true picture of the depreciation: The company could require tremendous re-investment every year in equipment, as opposed to depreciation which is essentially an accounting tool that helps to spread out the decreasing value of significant assets but doesn’t actually cost a company significant cash outlays
EBITDA should be part of your algorithm of analysis, but it should not be the only tool at your disposal. Be sure that you have a clear understanding of the true financial picture of any company you are considering purchasing or merging with. As always, consult with trusted specialized attorneys as you enter the research and negotiation phase and avoid hasty decisions.
