Owners Week on defining EBITDA
When talking about buying and selling small businesses, everyone will be talking about this term.
EBITDA is used to compare the value in one business to other businesses. What’s important to know about EBITDA is that it’s basically the Revenue minus Business Expenses. Let’s say you buy all the parts to make a motorcycle. You build the bike and sell it.
Hopefully you made a little more money than it cost to buy parts and put the bike together. If you made some money after all the expenses, that’s called profit. Ok, so what is the difference between EBITDA and profit? We know the terms are similar but let’s find out why EBITDA and Profit are different.
Sometimes business owners use accounting practices to reduce their profit on paper. For example, when it’s time to pay taxes each year, it’s common practice to show as little profit as possible. That is because businesses are taxed ultimately on profits. However, when it comes to selling a business, owners want to show as much profit as possible to show the highest earning potential of the business.
In order to get a clearer picture of the profit potential of a business, an owner can remove all the accounting deductions and display just the money made from running the business. That’s typically what we call profit.
But remember, the term “profit” might include accounting deductions depending on the level of specificity. But by it’s very definition, EBITDA does not include these deductions. That is to say EBITDA does not include accounting mainstays of interest, taxes, and depreciation.
When you want to know how much profit a business made without the accounting tricks, tell them you want the EBITDA please.