Jargon is rife in the realm of mergers and acquisitions, and few terms send clinicians running for hills faster than EBITDA.
The acronym stands for Earnings Before Interest, Taxes, Depreciation, and Amortisation.
Understanding this crucial metric can help buyers and sellers understand the true value of a business, its cashflow situation, growth prospects and much more.
But what is it, and how do we measure it?
In this article, we’ll show how to calculate EBITDA and explore its role in the M&A process and exit strategies. We’ll also discover why EBITDA is an invaluable tool for valuing practices, identifying synergies and forecasting cash flow.
Useful Definitions
Put simply, EBITDA is a measurement of a company’s profitability before the impact of financing, taxes, and non-cash expenses of depreciation and amortisation.
Most business owners will already have an all-too-painful working definition of interest and taxes. So before digging into the really good stuff, it would be helpful to define the remaining key concepts: depreciation and amortisation.
Depreciation measures the amount by which tangible assets lose their value over time. For example, wear and tear and rapid advances in digital dentistry make the fancy scanner you purchased in 2010 worth a fraction of what you originally paid. That’s depreciation.
Amortisation, meanwhile, refers to the same process with intangible assets like patents, intellectual property and software.
EBITDA is a financial metric used to measure a company’s operational performance. It measures a company’s profitability before accounting for the impact of financing, taxes, depreciation and amortisation.
Calculating EBITDA
While amortisation can be elusive to evaluate accurately, calculating EBITDA is easy once you understand it.
Let’s say Pluto Partners provides the following simplified practice valuation:
Net income: £500,000
Interest expenses: £20,000
Tax burden: £10,000
Depreciation: £8,000
Amortisation: £2,000
Now we know these figures, all we have to do to calculate EBITDA is add them together. In this case, our EBITDA would be £540,000. Simple!
Valuation and Cash Flow
Unlike net income alone, EBITDA shows profitability before considering financing, taxes, and non-cash expenses, so it’s a more accurate picture of operational performance.
But it’s not just an indicator of value. Because EBITDA gives a picture of available cash in the business, it’s also a helpful metric for understanding cash generation and flow.
Comparing EBITDA to net cash flow gives us insight into cash generation. A high ratio indicates that a practice generates significant cash relative to profitability.
That said, it’s also important to understand that EBITDA isn’t the same as cash flow.
Therefore, it’s crucial to build an accurate picture of both when assessing financial performance.
We can also compare the growth in EBITDA to the growth in net cash flow. If EBITDA growth outpaces, it could signify that the business is becoming more leveraged or is investing in growth opportunities.
Identifying Synergies
In mergers and acquisitions, EBITDA is an invaluable tool for identifying synergies—cost savings that would not be possible if the companies remained separate.
We can understand potential cost savings and revenue boosts by comparing the two companies’ EBITDA margins (the ratio of EBITDA to operating profitability). If the combined company has a higher EBITDA than the two companies alone, there is good potential for cost savings and improved revenue.
We can also compare the companies’ EBITDA multiples (the ratio of EBITDA to market capitalisation). A lower EBITDA multiple for the combined company is a good sign that an M&A will create shareholder value.
Once we understand and compare EBITDA, we can also use it to identify operational synergies: Imagine a merger between two practices. The first has an exceptional marketing department, while the second has a world-class surgical team. In this case, a successful merger could lead to an uptick in implant revenue.
The Drawbacks
For measuring operational performance, EBITDA is invaluable—but not infallible.
Many factors, such as financing and investment performance, are left out of the equation, and these can all impact performance.
It’s also easy to manipulate and inflate EBITDA by purchasing assets with high depreciation and amortisation rates or inflating revenues while keeping expenses low.
So, while it’s a more accurate picture of operational performance than net income alone, EBITDA should always be assessed carefully alongside other financial metrics and records.
Don’t Sweat it
We understand EBITDA, so you don’t have to. Contact us to discover how Pluto Partners can provide a comprehensive practice valuation, growth plan and full M&A support.
Dr Faresh Desai
Ascent Dental Group
Max understood our business, what was important to us as owners and put us in front of several buyers before we selected our partner for exit and future growth strategy. We could not have achieved the deal without Max and his team at Pluto.