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Tags: adjusted net income, business valuation

Comments & Replies: 5     Views:     Post ID:     Comments About This Glossary Term

Contributor: Business Broker, Northern California
Part of the purpose of EBITDA is to represent a number the current owner of the business is able to generate before paying any income taxes. By arriving at this number it can then be applied to a business valuation of the business by comparing it to similar size businesses in terms of revenue or EBITDA to see what price they sold and guide on the value of the company for sale. EBITDA is also used by lenders to decide their value of a business and how much they would be willing to lend if a buyer brings a downpayment. EBITDA is similar to SDEor Sellers Discretionary Earnings except EBITDA includes the salary of a manager to run the business whereas SDE excludes any owner or management compensation.

EBIDTA, an acronym that represents the Earnings Before Interest, Taxes, Depreciation and Amortization. These categories are also considered Add Back items and removed to establish an unclouded look at the value of a business. One simple example is, if one business is paying loan service and the other is not the value of one over the other should not typically be effected.

Contributor: Transactional Attorney
EBITDA stands for "earnings before interest, taxes, depreciation, and amortization". It is typically used as an indicator of how profitable a business is relative to other businesses in different areas (which can impact tax burdens), different debt structures (which can impact interest costs), and differences in how business assets are depreciated and deductions are amortized (which can vary depending on factors which may not relate to the overall financial health of the business). Depending on the industry and revenue, a multiple of EBITDA may be used as one metric when determining a business' valuation.

Earnings Before Interest, Taxes, Depreciation, and Amortization. This represents the "raw earnings" of the business enterprise, before deducting the enterprise costs of doing business, involving actual cash outlays (interest and taxes) and book adjustments (depreciation and amortization). When comparing two or more business operations, EBITDA provides a more objective picture of each business, without consideration of how the owner has financed or organized the enterprise.

The commonly used acronym EBITDA, "earnings before interest taxes depreciation and amortization," is an accounting expression applied to business profit and loss reports. The 'before' means calculation of a company's earnings - also described as 'net earnings' or 'net profit' - prior to deductions for business expenses that are not directly related to its operation. Instead, they are discretionary expenses that a business owner chooses to claim as costs of doing business to reduce the earnings subject to income tax. As this calculation is discretionary to the business owner, he or she will use different figures for each of the four items, or may assign no amount to them at all, compared to the values applied to them by previous or subsequent owners of the same business.

For example, the EBITDA reported by the owner of a market was: $1,200.00 paid last year for interest charged on the loan he received to help fund purchase of the business; $6,640 submitted with federal and state tax returns owed on income generated the prior year; $750 listed on the company's depreciation schedule, representing the annual decline in market value of the refrigeration system, freezers and other capital equipment used in the business; and $3,600 calculated for annual amortization (write-off) for each of the five year life of the $18,000 covenant not to compete the owner purchased from the prior owner as part of the price paid for the business.

The sum of these items, $12,190, was deducted from the total of $64,382 that remained for the owner's personal use last year. That remainder, EBITDA, was determined after subtracting, from the store's gross income, the costs of purchases for all inventory needed for sale to customers, payroll and related labor costs, rent, utilities, insurance, maintenance, professional fees and the other expenses incurred in order to conduct business. After the deductions, the owner showed $52,192 in taxable income, requiring a lower tax payment than had those deductions not been entered on the books.

The reason earnings are calculated both ways, before and after those deductions, is so that when selling the business the owner can demonstrate that a new owner, may collect the higher figure, the EBITDA, and then choose which of any of those deduction categories he or she wishes to use when computing taxable income.

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