What is EBITDA and how is it used to value businesses? (2024)

EBITDA company valuation guide for business sellers

EBITDA is an acronym for ‘earnings before interest, taxes, depreciation, and amortisation’, and can be used to determine the financial position of your business as part of the business sale process. When valuing a business to calculate how much it is worth, your business broker or professional business valuer may use common company valuation metrics, such as EBITDA.

Earnings before interest, tax, depreciation & amortisation is essentially net income, i.e., business earnings before interest and tax payments are deducted and the depreciation of intangible and tangible assets is taken into consideration, which we explain.

Depreciation – The changing value of tangible assets throughout their useful life, such as equipment, machinery or fixtures

Amortisation – The fluctuating value of intangible assets over time, such as intellectual property, software or domains

By understanding the meaning of EBITDA and what defines EBITDA, the valuation method can be used to assess company profitability by investors or by a business valuer when preparing your company for sale. EBIDA is an acronym for ‘earnings before interest, depreciation, and amortisation’ which may also be referred to throughout the business valuation process.

How to use EBITDA to value a company

The EBITDA valuation method consists of calculating earnings before interest, tax, depreciation & amortisation, which is then divided by company revenue to establish the EBITDA margin. The basic EBITDA valuation formula can be seen below.

EBITDA = Operating Profit + Depreciation+ Amortization

EBITDA is used as a valuation metric as it removes external accounting factors and non-operating expenses from view, focuses on the operating performance of the business and takes into consideration an approximate value of company cash flow. An EBITDA valuation can be used to compare similar businesses through the application of EBITDA industry multiples.

What are EBITDA multiples by industry?

A common question when discussing EBITDA valuations is – what are EBITDA multiples and why are EBITDA multiples used when valuing a company?

EBITDA multiples are fixed ratios that are allocated to sectors and used when valuing businesses across different industries. EBITDA valuation multiples are industry benchmarks based on similar sales, including mergers & acquisitions (M&A), and professional recommendations from equity analysts. EBITDA multiples by industry reflect on the average price of a company, making an EBITDA valuation an essential part of the business exit planning process.

Industry multiples vary significantly across different industries and sub-sectors, for example,

The growth potential of a business will influence the multiple, for example, a business with higher potential for growth and expansion is likely to have a higher multiple.

As part of an EBITDA valuation, the industry multiple, or EV (enterprise value) will be multiplied by EBITDA. Enterprise value is the total value of a company, including debt and equity. Enterprise value is often used to address the overall image of the business, rather than restricting this to asset value, commonly referred to as an enterprise valuation.

Industry multiples minimise the risk of undervaluing or overvaluing businesses and should be applied on your last year’s company projections and deducted to date. They play a useful role for prospective buyers by helping them forecast investment returns, however, an EBITDA valuation should be used in conjunction with supporting factors to build a contextual image of company cash flow, including capital expenditure.

What is excluded in an EBITDA valuation?

An EBITDA valuation is fit for purpose and can be used to accurately compare businesses, however, take note of additional costs such as capital expenditure and working capital to reduce the risk of overstating cash flow.

Capital expenditure – Also known as CapEx, capital expenditure is money used to maintain, improve and acquire long-term, fixed business assets, such as property, land, equipment, machinery and fixtures.

Capital expenditure can be used to promote future company growth by making strategic acquisitions and executing repairs where required. The nature of these costs is unpredictable and can vary in value, from incurring minimal expenses, to pushing the business into a loss under extreme circ*mstances

Working capital – Working capital is the money spent by a business to maintain company affairs and pay bills when they fall due and indicates short-term financial health. The liquidity of a business can be measured by calculating the difference between company assets and liabilities.

If the working capital of a business is in decline, this may restrict growth potential as the business will be unable to facilitate new ventures

Capital expenditure and working capital must be considered when calculating the EBITDA industry multiple to paint a full image of the financial position of your business. Adjustments may also be made to EBITDA in the event of activity that is non-recurring or one-off.

EBITDA Business Valuation

At Selling My Business, we can arrange a EBITDA company valuation conducted by our in-house team of professional business valuers. We understand that each business is unique, which is why our valuations extend beyond financial data and industry multiples.

We have a vast database of comparable evidence based on previous sales, including sale price, valuation price and filtered by granular details such as geographical location, opening hours, and the quality of fixtures and fittings, including the replacement value and auction value. This data is invaluable to the business valuation process and can minimise the risk of undervaluing or overvaluing.

For more information, get in contact with a professional business broker at Selling My Business and arrange a free business valuation.