Money IQ: What is EBITDA

Money IQ

What is EBITDA

What is EBITDA? Pronouned ē-bi-da or i-bi-da. If you watch or listen to any of the business channels or radio stations you will hear the analysts discuss a company’s EBITDA as a performance measure, a cash flow measure or even use it occasionally as a valuation tool.

Either way, EBITDA is not just for large companies or corporate analysts, it is used every day by our local lending institutions when evaluating your company for new or existing loans. Simply stated, EBITDA measures the operating performance of your company with certain limitations. 

EBITDA is an acronym for Earnings Before Interest Taxes, Depreciation and Amortization. It is a financial calculation used by a lot of firms, largely lending, credit and financial analyst firms as a means of measuring you or your company’s operating ability and often your ability to service your business related debt obligations. What this calculation does, it takes your company net income and adds back your interest expense, taxes, depreciation and amortization and allows you or others to analyze cash flow absent the effects of financing and other accounting decisions (tax accounting, depreciation methods, life of assets, etc.) “It’s the easiest profitability measure that approximates for cash flow,” says Mark Haskins, professor of business at the University of Virginia’s Darden School of Business.

This number is then compared with industry averages, and it is used as a measure against your monthly or annual debt obligations. When assessed against your monthly, quarterly or annual debt obligations, lenders are looking to see that you have the capacity to make your contractually required payments. Lenders and others like to see that you can service your payment obligations at a ratio that exceeds 1.00:1.00, most lending financial institutions like to see a 1.00:1.00 plus a margin, typically 20 percent or more, so that your EBITDA to consolidated debt payment obligations is 1.20:1.00.

For example, your company has a year-end EBITDA of $120,000 (annual net income plus add back interest expense, taxes, depreciation and other amortizing expenses). Assume for this example that your total monthly payments are $8,000; $8,000 X 12 months = $96,000. Now calculate your debt coverage ratio by dividing your EBITDA/Annual Debt Service or $120,000/$96,000 which equals 1.25 times. This calculation it would demonstrate that you can meet your annual debt obligations plus have an extra margin of .25 or 25 percent. 

Please keep in mind, this is merely one calculation and other factors will be considered such as capital expenditures, other uses of cash, history of your firm, management and other items.   

Editor’s note: Al Hernandez is a Senior Commercial Banker with Los Alamos National Bank and currently runs the Albuquerque market for the bank. Al has over 23 years of banking experience that includes running banks and commercial lending.

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