Measuring the performance of a business can take many shapes. But there is one indicator that rises above them all, no matter the size or history of the business. That’s EBITDA. It’s not just accountant talk.
EBITDA (your earnings before interest, tax, depreciation and amortization) provides a way to evaluate a company's performance without having to factor in financing decisions, accounting decisions or tax environments.
Whether you’re in growth mode or looking to sell, there are ways to improve and hurt your EBITDA. The goal is for it to be sustainable.
During sales negotiations, both sellers and buyers hone in on EBITDA. Once this is established, a multiple of the earnings are applied to determine the value of the company. It is very important that the EBITDA can be validated and that it is sustainable. Often the year that a company plans to sell they will have a substantial positive spike in earnings. This will likely need to be explained in detail to the buyer.
Cost cutting moves and add-backs are a natural part of the process. Some help you and some don’t. Here’s a look at how some common ones stack up:
Evaluating the costs of doing business and reigning in expenses is a constant responsibility of leaders. They all may look like they are helping your EBITDA, but buyers do not see the value in both.
Three moves that won’t help:
- Not filling needed positions (understaffed)
- Reducing employee benefits, such as 401K match and healthcare insurance
- Making other non-sustainable adjustments (accelerating rebates, reducing rent expense below market, eliminating marketing, etc.)
Three moves to make:
- Eliminate underperformers (and replace if needed)
- Optimize service margins (supply levels, staffing, parts utilization, etc.)
- Clean up old inventory or excess quantities
As an owner, you could pull back on expenses and not make investments to elevate your EBITDA. But buyers recognize that it is not sustainable and investments will need to be made to achieve future performance.
There are expenses that can be added back to the profits of the business to improve a company’s profit picture. Some make good sense and others will not fly with buyers. Here are some examples of each:
Ideas that won’t fly:
- Eliminating owner’s wages if filling a role that needs to be replaced (i.e. lead salesperson)
- Taking credit for assumed buyer synergies (seller is paid for what they’ve done, not what the buyer is going to do)
- Adding back marketing expenses, charitable contributions, sales incentive trips or other normal business expenses
Ideas that will fly:
- Owner’s personal expenses
- Owner’s excess compensation above market value
- Third-party professional fees
Whether it’s an expense reduction or add-back, the common denominator is sustainability. As owners, we get emotionally attached to the business. We know what it took to build it, and we want to position it as best as we can. Preparing to sell requires owners to separate feelings from facts. It’s a good practice to try and “think like the buyer” and not let feelings prevail over logic.
How sustainable is your EBITDA? That’s the key question to answer as you hone in on your company’s value. I’d be happy to share an outsider’s perspective of your company and talk more about smart cost-saving moves and add-backs.