As an automotive business investor, you have a lot to consider. You have to analyze potential cash flow, net income, inventory & capital, and projected revenue to measure the value of your investment.
There is, however, another way to gauge how profitable your business venture may be and if it is worth the financial risk. The metric is known as earnings before interest, taxes, depreciation, and amortization (EBITDA).
While there are limits to what the metric can appraise, it may provide the basis that helps you make what could be your most important financial decision yet. Below, we take an in-depth look at EBITDA to give you a better understanding of the concept.
EBITDA: Measuring Profits
The theory behind EBITDA is simple. It is an indicator of potential profitability that a business offers. While many business owners utilize the model to assess their company’s current financial portfolio, the same model can be used to predict potential profitability based on past performance.
EBITDA follows a standard formula:
Net income + Interest + Taxes = EBIT + Depreciation and Amortization expenses = EBITDA
EBITDA helps you break down baseline financial components and then build from there. The components include:
Earnings Before Interest and Taxes
If you are contemplating purchasing an automotive business, you need to evaluate the company’s ground-level earning potential before interest and taxes.
To begin, take the automotive company’s actual or projected total revenue and subtract all actual or projected expenses, such as the cost of goods sold and operating expenses.
Next, calculate your earnings. Then, add the amount you will pay in interest and taxes back into the earnings.
Allocate the cost of the business’s tangible assets over their expected lifespan and subsequent decline in value. By depreciating the value of the long-term assets, you can deduct the cost of assets for purchases as a business expense.
The only caveat to calculating depreciation is that you must adhere to IRS rules and regulations.
Finally, you need to allocate the cost of all intangible assets over a period of time. An example of intangible assets would be amounts allocated to goodwill. As with depreciation, you should amortize any intangible asset over to its designated useful life, according to IRS rules.
Is EBITDA Practical or Useful?
Yes. While the are other models or approaches for determining a company’s current or potential future profitability, EBITDA is considered by many experts to be the most straightforward path to crunching the numbers and reaching a bottom line.
From an accounting standpoint, EBITDA flies in the face of standard accounting principles and is not always seen as an acceptable method for establishing a business’ profitability potential. The real issue, however, is not whether EBITDA is utilized as a measuring tool, but, rather, what it is replacing. For instance, EBITDA is generally not viewed as a substitute for determining a company’s cash flow or related accounting issues such as accrual accounting or cash accounting.
EBITDA is also heavily criticized for not placing enough emphasis on interest, taxes, depreciation, or amortization—key components of the equation. The two latter components are bedrock accounting methods used to spread out the expense of large capital investments.
Finally, many analysts and investors see EBITDA as an oversimplified approach to accounting that can potentially cause business owners or investors trouble down the road.
Still, EBITDA may be a good jumping-off point for an investor looking to land their first venture.
Automotive Business Brokerage for Buyers and Sellers
AutoCenter Sales has extensive experience and knowledge to help you with the purchase or sale of your automotive business. We have the capabilities to handle all sides of the transaction process, which makes for a more thorough and seamless transition.
To find out more about our services and products or to schedule a consultation, call us at 1-800-874-5793. You can also message us at email@example.com.