Small Biz Watch: Understanding EBITDA
How much is your small business worth? Or more important, what do other people—like potential buyers—think it's worth? Jeff Cornwall, director of the Center for Entrepreneurship at Belmont University in Nashville, Tenn., has a great post on his blog, The Entrepreneurial Mind about the valuation process. He says the only reason that reputation, employees, or customer base has any value to a prospective buyer is that they all can contribute to cash flow for the new owner. To determine cash flow, the metric that matters is EBITDA (Earnings Before Interest Taxes Depreciation and Amortization):
"That is the best measure of cash profits of a going concern for most businesses. Using EBITDA makes comparing businesses possible as it controls for financing, corporate form, and accounting practices related to assets which all can vary. So what does a buyer look do with EBITDA? In the simplest sense they use a multiple of EBITDA to give the business a value. The higher the multiple, the stronger they expect earnings to be going into the future. In most cases, the multiple they use on EBITDA ranges from 3 to 8. Now that is a huge swing in possible values. A company with EBITDA of $1 million could be worth anywhere between $3 million and $8 million!"
So which multiple is applicable to your business? There are a lot of different factors that go into the calculation, such as your market position, customer base, and the type of business you're in.