What is EBITDA and how is it used to value a business?

2 min read.

You often hear a company was sold for x times EBITDA. So, what is EBITDA and how is it used to value a business?

EBITDA stands for Earnings Before Interest, Taxes, Depreciation, and Amortization. EBITDA is often used to determine a company’s value and the purchase price in a business acquisition transaction. A business can be valued by applying a multiple to its maintainable EBITDA.

EBITDA is a preferred metric by many valuation and M&A professionals because it gives a more standardized view of the operating profitability of a business in comparison to similar businesses in the same industry.

For example, EBITDA excludes interest expense which is related to the debt structure of a specific company. A buyer of this company may implement a different debt/capital structure and therefore, the actual interest expense incurred by this subject company is not relevant to the potential buyer.

Similarly, amortization is also excluded from EBITDA. Amortization and depreciation expense is dependant on the subject company’s accounting policy on how long and at what rates capital assets are amortized.

Once the maintainable EBITDA is determined, a multiple that is appropriate for the risk profile of the company and its industry is applied to it to arrive at the business’s value. EBITDA multiples vary from sector to sector. For illustrative purposes, the graph below shows that the manufacturing sector typically has higher EBITDA multiple (at 4.9 times EBITDA) than say for the accommodation and food services sector (at 2.2 times EBITDA).

Median Selling Price/EBITDA By Sector (Private Targets) – DealStats Value Index | 3Q 2022

However, EBITDA is not the only figure to consider in determining the intrinsic value of a business. Relying solely on EBITDA could be detrimental to the buyer. The calculation deliberately excludes key figures that include capital expenditure (Capex), overall liquidity, working capital and income taxes. Depending on how the subject business has been run and the industry it operates in, Capex costs could be a large part of the bigger picture of the ultimate cash flows from the business that a potential buyer would likely receive if they purchase the business.

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