The Significance of EBITDA in valuing your company

When it comes to valuing a small or medium-sized enterprise (SME), understanding EBITDA is crucial.

EBITDA, which stands for Earnings Before Interest, Taxes, Depreciation and Amortisation, is a financial metric that plays a pivotal role in determining the value of many businesses.

In this blog post, we’ll delve into the importance of EBITDA in SME valuation, explore adjustments needed for a precise calculation and shed light on typical multiples used by valuers during a sale.

Importance of EBITDA

Profitability Assessment

EBITDA provides a clear picture of a company’s operational profitability, stripping away non-operating expenses like interest and taxes.

This metric helps prospective buyers or investors evaluate a business’s core earnings capacity.

Comparability

EBITDA allows for the easy comparison of SMEs within the same industry.

By focusing on operational performance, it minimises the impact of financing choices and accounting methods, making it an excellent benchmark for assessing value.

Cash Flow Proxy

For many SMEs, cash flow is a critical factor.

EBITDA serves as a good proxy for cash flow because it disregards non-cash expenses like depreciation and amortisation, making it a reliable indicator of a company’s ability to generate cash.

Adjustments to EBITDA

To arrive at a more accurate EBITDA figure for valuation, adjustments are often necessary.

Some common adjustments include:

Owner’s Compensation

If the owner’s salary is either too high or too low compared with industry standards, it should be adjusted to reflect market rates.

Non-recurring Expenses

Exclude one-time expenses or income that aren’t expected to recur in the future.

Related-Party Transactions

Adjust for transactions with related parties that may not represent fair market value.

Working Capital Changes

Account for changes in working capital requirements that can affect cash flow.

Typical Multiples

Valuers often use EBITDA multiples to estimate the value of an SME.

The multiples vary by industry and market conditions.

For example a SaaS (Software-as-a-Service) company can achieve significant multiples between 6 to 8 times EBITDA (sometimes higher) whilst a manufacturing business would typically achieve 4 to 5 times EBITDA.

Added to these valuations would be any excess working capital held in the business.

Understanding the value of EBITDA

In conclusion, EBITDA is a fundamental metric for SME valuation.

It offers a clear view of a business’s profitability, facilitates comparisons and serves as a proxy for cash flow.

However, precise valuation often requires adjustments for unique circumstances.

When conducting a valuation, considering the appropriate multiples for your industry is crucial for arriving at a realistic and competitive price, whether you’re buying or selling an SME.

Looking to sell your business?

If you’re an SME owner looking to sell your business, the process can be complex and challenging.

This is where experienced professionals like Friend & Grant Accountants can make a significant difference.

How can we help?

At Friend & Grant, we understand the intricacies of SME valuations and sales.

We can provide an honest assessment of your business, highlighting both its strengths and weaknesses.

Our team can help you with the financial aspects, ensuring your financials are in top shape for potential buyers.

Our services go beyond just valuation; we can also assist you in getting your business ready for sale.

We can work with you to identify areas that may need improvement, helping you enhance your business’s appeal to potential buyers.

And when you’re ready to take the plunge and put your SME on the market, we’ll be there to assist throughout the sales process, providing guidance and support to maximise the value you receive.

Our Services

To learn more about how Friend & Grant Accountants can assist you in selling your business, visit our Selling a Business page.

With our expertise and dedicated support, you can navigate the complex world of SME valuation and sales with confidence, knowing that you have a trusted partner by your side.

Blogs related to selling your business

Take a look at our other blogs on the topic valuing and selling your business

Maximising the Value on Sale of Your Business: The Reality Check You Need

Unlocking the Secrets of SaaS Company Valuation: Some Key Elements and Strategies

The content in this blog is correct as at 14th February 2024. See terms and conditions.