The acronym EBITDA stands for "Earnings Before Interest Taxes, Depreciation and Amortization." EBITDA represents operations earnings before deducting interest for factors such as debt, taxes, non-cash depreciation, and the amortization of tangible or intangible assets.
EBITDA is ofter the first method buyers use to value a company. It allows buyers to predict the operating cash an enterprise can generate if net working capital is maintained.
EBITDA has its share of critics. Many investment experts consider discounted cash flow calculations as a better valuation method. One of EBITDA's most significant drawbacks is how it neglects capital expenditure requirements in its estimate. However, thanks to its relative ease-of-use, EBITDA remains one of the most (if not the most) popular ways for buyers to value a potential acquisition.
As a result, business owners need to focus on increasing their EBITDA. Higher EBITDA means a higher valuation.
How to increase EBITDA
There are multiple methods for business owners to engineer a higher EBITDA for their company (that don't involve fraud, obviously). Strategies for engineering EBITDA fall into two broad categories: business practice improvement and accounting.
Improving EBITDA by enhancing business practices boils down to this: The more you can streamline operations, the more your EBITDA will increase as a result of increased organizational efficiency. Research from Deloitte shows that a high-quality management system capable of organizational efficacy and fast decision-making is the most critical factor in increasing EBITDA.
Additionally, every decision-maker in a sale - from managers to the CFO - should work together to trim organizational fat and enact stringent cost-control processes. Done well, improved business practices can easily net a seller millions of dollars more via increased EBITDA.
Business owners can also use a variety of accounting methods to grow EBITDA:
Record equipment leases as capital leases instead of operating leases. This circumvents the issue of EBITDA not accounting for capital expenditures in its valuation. By recording equipment leases as capital, you avoid impacting earnings with payments towards the lease. You also add back depreciation on the asset and interest on the debt, increasing EBITDA.
Record cash outlays as assets on the balance sheet, not expenses on income statements. Implementing this practice allows you to simultaneously increase assets and reduce expenses, both of which will drive up EBTIDA. As a side-note, most expenses that you can justify as having economic value for the future of the company - such as the development of new employee management software or long-term improvement of operating systems - can be recorded as assets. Another example are significant repairs and maintenance costs that are often expensed in privately held businesses to reduce net income and, correspondingly, income tax at the detriment of higher EBITDA. Costs that have future economic value that can be measured might also be eligible for capitalization. Capitalization of costs is a gray area that requires just as much qualitative justification as quantitative. Seek professional advice from your accountant to determine if some of your costs are eligible to be capitalized.
Make sure you count inventory accurately (and regularly). Move calculated inventory from income statements to the balance sheet. A periodic count can move the inventory still sitting in the shop or warehouse off of the income statement and on to the balance sheet. This increases EBITDA and helps buyers better understand the working capital needs of your business more accurately.
Revenue Recognition. Revenue recognition is an accounting principle that determines the specific conditions under which revenue is recognized or accounted for. Revenues are recognized when they are earned and corresponding expenses are recorded to match that timing. But when is the revenue actually earned? Many businesses will record revenue when a project is completed, but there are many instances when partially completed jobs will straddle a company’s year-end. If revenue was recognized for the percentage of the work completed on those projects, the profit margin would be recorded on the income statement and increase EBITDA for that period.
Acquire a business. If you can swing it, acquiring a new business is the easiest way to increase EBITDA dramatically.
With a little know-how, owners can increase their EBITDA - and the value they generate from selling a business.
To learn how your company can benefit and best position itself within the M&A landscape, call or email me now to receive 3 hours of free consultative analysis. Our analysis offers clarity, based on your objectives, if a full or partial exit, recapitalization, divestiture, acquisition or pre-sale exit strategy provides the greatest benefit to you and your company.
Vercor has been delivering M&A expertise for over 25 years. We serve as a trusted partner to help build long term, iterative strategies that ensure you are positioned to meet your unique personal and financial goals whether it is selling, recapitalizing, acquiring or divesting of a division. Now is the time to evaluate, strengthen, prepare and increase the market value of your company regardless of your timeframe.
Todd Cummiskey
Vercor
704-926-6564
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