EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization) - the most popular transactional indicator
What is EBITDA?
The simplest definition of EBITDA is that it is the net profit generated by a company from its operating activities. More specifically, this indicator does not deduct the following costs from the company's results:
· costs related to interest on borrowed obligations (e.g., loans),
· depreciation of fixed assets and intangible assets as a cost that does not represent an expense,
· income tax.
In other words, EBITDA represents the profit that does not take into account income tax and the costs of interest and depreciation.
Valuation method using EBITDA
The valuation of a company can involve comparing the company being valued with other companies in a similar line of business. Comparative data is obtained from companies that are required to disclose their financial information (publicly traded companies) or companies whose acquisition terms have been disclosed. In reality, it is difficult to find companies that can be directly compared on a one-to-one basis with the company being valued. Therefore, an additional element is the use of an appropriate multiplier. As a result, the value of the company is usually determined as the product of the multiplier and the EBITDA value in the last full financial year (or another point in time agreed upon by the parties to the transaction). The multipliers vary for different industries and depend on factors such as growth prospects and the size of the company.
Why is it worth using EBITDA?
The data considered in the calculation of EBITDA allows for a reliable valuation of the company in terms of its core operating results. The impact of the following factors becomes insignificant:
· income tax, which may be significant if the company is still offsetting losses from previous years or benefiting from some form of tax privileges. As a result, companies with the same operating profit may show different net profits;
· interest costs on borrowed obligations, which would also "distort" the picture of the company. For example, a company financing its operations from its own funds versus a company relying on external financing would show a lower net profit for the latter, despite having the same operating size;
· depreciation costs, which, as a cost associated with expenses incurred in the past, do not involve the outflow of cash at the time of depreciation and significantly reduce the company's final profit.
Additionally, one-time events that distort the company's real and recurring results are typically not considered in the company valuation.
Moreover, the valuation method using the EBITDA indicator is generally less time-consuming and less costly than the income-based approach (valuation based on financial forecasts).
Is the indicator appropriate in every case?
In certain situations, the EBITDA indicator and the valuation based on it may not reflect the current value of the company. This method may not be suitable in the case of a sudden industry or market downturn. The valuation will be based on the results achieved in the last full financial year, i.e., before the economic destabilization, and will not take into account its impact on the company's condition. This situation is currently evident due to the COVID-19 pandemic.
There is no definitive answer as to which method of company valuation is the best. Each method utilizes different information and provides different results, and the choice depends on the current market conditions. Comparing EBITDA indicators is currently a fundamental action that serves as a compromise between the less reliable asset-based method and the more costly income-based method.