June 14, 2023
When it comes to measuring a business’s profitability, there are a variety of metrics to consider. One commonly used metric is EBITDA, which stands for earnings before interest, taxes, depreciation, and amortization. While EBITDA and net income are often used interchangeably, they actually reveal different insights into a business’s financial health.
Let’s explore the difference between the two, as well as why EBITDA is such a valuable metric to track when selling your business.
EBITDA means exactly what this acronym stands for: earnings before interest, taxes, depreciation, and amortization; while net income is the total profit a company earns after all expenses have been deducted.
EBITDA is most often used as a measure of a company’s operating performance, as it excludes non-operating expenses like interest and taxes. Net income, on the other hand, provides a more comprehensive view of a company’s profitability, as it takes into account all expenses.
While a potential buyer will look at both these important metrics to evaluate a company’s financial health, a business’ EBITDA is what buyers really hone in on.
EBITDA is a valuable metric to track in business valuation because it provides a clearer picture of a company’s operating performance. By excluding non-operating expenses like interest and taxes, EBITDA allows investors to compare the profitability of different companies on a more equal footing.
Additionally, EBITDA can be used to calculate a company’s enterprise value, which takes into account both its equity and debt. This makes EBITDA a useful tool for evaluating potential acquisitions or mergers.
That said, it’s important to remember that EBITDA is one of several metrics and should be used in conjunction with other financial indicators when evaluating a company’s overall health.
EBITDA is calculated by adding back non-operating expenses like interest and taxes to a company’s net income. Whereas net income is calculated by subtracting all expenses, including interest and taxes, from a company’s total revenue.
Remember: while net income provides a more comprehensive view of a company’s profitability, EBITDA is useful for comparing the operating performance of different companies.
While EBITDA and net income are both important financial metrics for business valuation, they do have their limitations.
EBITDA can be misleading, as it does not take into account capital expenditures, which are necessary for a company’s long-term growth and sustainability.
Net income, on the other hand, can be impacted by non-operating expenses like interest and taxes, which may not accurately reflect a company’s operating performance.
These shortcomings are why it’s so important to use both metrics in conjunction with other financial indicators, and to consider the specific context of a company’s financial situation.
While both important financial metrics, EBITDA and net income clearly serve different purposes.
To sum it up, EBITDA is often used to evaluate a company’s operating performance and its ability to generate cash flow. This is why it’s typically used to compare companies in the same industry and/or to evaluate a company’s performance over time. The best M&A firms will assist business owners to calculate EBTIDA when preparing a business for sale.
Net income, on the other hand, is a measure of a company’s profitability after all expenses have been accounted for. Therefore it is often used to evaluate a company’s overall financial health and to determine its ability to pay dividends or reinvest in the business.
Woodbridge International assists mid-sized businesses to accurately calculate EBITDA in preparation for sale. If your company has an annual revenue of $5M plus, contact us for a free valuation.