How’s Your EBITDA? Put on your Owner Hat for a minute
I know, you wear lots of different hats every day. There is so much to get done, and there is not always someone specifically assigned to do it.
That is the nature of a Small/Medium Business (SMB). But those little things all need to be done, so we constantly switch roles (or change hats) and make it happen.
The problem is that SMB’s often are so busy changing hats, that they lose focus on the big picture. Are you so busy flying the plane that you forget about the destination?
Alright, so slow down for a minute here, Turbo, and put on your ownership hat.
What should be your expectations of success as an SMB owner? Isn’t it obvious? Your expectations should be the same as they would be if you were involved in any investment. You should expect to receive income, and/or growth in your investment value.
I’d like to focus on increasing your investment value for this article.
Ever hear the term EBITDA? If not, it‘s time to make the acquaintance. EBITDA is the acronym we use for Earnings Before Interest, Taxes, Depreciation and Amortization. It is one of THE MOST IMPORTANT MEASUREMENTS of your company.
Why do I think that? Well, first of all, it’s not just me that thinks that. All business and financial advisors pay strict attention to this measure. Why? Because it tells us in a very clear way how well the business is performing financially. EBITDA determines the ability of the business to generate income from its regular operations, before any odd ball transactions. It also determines how much cash flow can be generated by the business.
That is why we pay a lot of attention to getting EBITDA right when we do your bookkeeping and accounting work. We want you to be aware of how well your business is performing on an ongoing basis.
Depreciation and amortization:
In calculating EBITDA, we eliminate non-cash expenses like depreciation and amortization because we don’t spend money on those items. We already spent the money when the assets were originally purchased. Thus, we remove them from the EBITDA calculation.
Interest Expense:
We also eliminate interest expense from EBITDA because it is not part of ongoing operations. Interest expense relates to debt acquired to finance assets, or the business itself. If you were to sell your business, the debt would be paid off as part of the deal. The purchaser would then acquire their own debt to finance the purchase.
Taxes:
Finally, we exclude income taxes from EBITDA because they have nothing to do with the operations of the business.
Once EBITDA is properly calculated, it’s time to examine the quality and risks behind your EBITDA:
- Business concentration risk. Do you have a revenue concentration of more than 20% in any one customer? Do you over-rely on a vendor for critical supplies? And what happens if you lose a key employee? Identifying and managing these potential soft spots will help insure your business against large fluctuations in activity.
- Look at the effect of pricing trends, volume sold, and the various revenue streams of the products and services you sell. How sensitive is your EBITDA to changes in price,quantity sold, and sales mix?
- Do you have enough working capital to support your operations? Are you straining to make payroll? Are you paying your vendors on time? Are you getting a steady paycheck? Managing your cash flow and staying discipled will keep your business strong and functioning with much less strain.
- Do you have any big ticket purchases lurking in the shadows? Generating enough EBITDA and segregating your cash into a separate pool will help you get ready for business expansion or equipment replacement.
If you haven’t done so recently, it’s time to have a “Board of Directors Meeting” with yourself to examine how your business is performing from an investment standpoint.
If someone were to approach you with an opportunity to invest in a business (your business), would you do it?
Hmmmmm… Something to think about. Call us if you’d like an objective, outside view of your business. We can help.