Buying or selling an automotive business is an important decision. Business owners need a full picture to best understand a company's valuation.
One term that comes up often when discussing business sales and acquisitions is EBITDA. Put in the simplest terms, EBITDA is an income statement metric. It is one of several ways to look at a business's operational performance.
At AutoCenter Sales, we can help you understand EBITDA's important role in helping you buy or sell your automotive business.
What Does EBITDA Mean, and How Does It Benefit You?
To understand the importance of EBITDA, we must first break down what it stands for. EBITDA is an acronym that stands for:
Net income + Interest + Taxes = EBIT + Depreciation and Amortization expenses = EBITDA
Just as it says, EBITDA looks at a company's net income before interest, tax, depreciation, and amortization. It is a shortcut to determining the cash flow an owner receives from a business during a given period. EBITDA is useful as an income statement metric for comparing companies to other companies and examining industry averages.
How EBITDA is Calculated
To determine EBITDA, first subtract the cost of sales from a company's revenue to determine its gross profit. Next, subtract the company's SGA (sales, general, and administrative) expenses. Finally, subtract R&D or research and development expenses if there are any.
When comparing industry metrics, EBITDA offers two major advantages:
It allows an organization to draw straightforward industry comparisons while eliminating extraneous factors.
It helps to determine the cash flow an owner receives from a business.
A Simple Formula When Buying or Selling an Automotive Center
Organizations often use multipliers of EBITDA to determine the value of a company. The information excluded from EBITDA is generally information that can vary.
The simplified way of looking at income metrics excludes this variable information based on the assumption that it may not be necessary to determine profitability.
Here are the reasons for excluding these figures:
EBITDA omits interest because it depends on a specific financing structure. Interest relates to the rate an organization borrowed and how much the organization borrowed. The rationale behind excluding interest is that interest does not depend on an organization's operational performance.
EBITDA excludes taxes because they can vary due to a variety of factors,
including the company's income, geographic location, legislation, and political climate.
Depreciation and Amortization
The types of assets a company invests in and how long it uses them are driving factors behind depreciation and amortization. The value of an asset on a balance sheet will change over time as it depreciates. However, this change is strictly for accounting purposes and does not impact the amount of cash the owner receives from the business.
Get the Full Picture When Buying or Selling Your Auto Shop
EBITDA can be useful as a tool for estimating profitability, but it excludes several important factors that can be useful in determining an automotive company's market value. EBITDA fails to account for any personal expenditures the owner may run through the business.
Also, EBITDA fails to evaluate the cash needed for capital expenditures. Both of these can significantly impact a company's profitability. When buying an automotive business, investors should view EBITDA as one piece of a much larger puzzle.
Is EBITDA Practical or Useful?
The short answer is “yes”. While they 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 the profitability potential of a business.
The real issue, however, is not whether EBITDA is utilized as a measuring tool but, instead, 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 investors looking to land their first venture.
Beyond EBITDA: What You Need to Look At
Though EBITDA is a helpful tool for assessing an automotive business's market value, it doesn't account for factors that could influence its future profitability or growth. As a buyer or seller, some of the other factors you'll need to consider:
Financial statements and tax returns (typically 3-5 years worth)
Balance sheet history, which can reveal potential cash flow issues
Intangibles (non-physical assets, such as brand recognition, intellectual property, etc.)
Potential capital expenditures to drive additional business growth
Post-closing interest levels, non-cash charges, and income taxes
If you're looking to buy an automotive business, you'll likely need to justify the business's EBITDA to obtain the necessary financing for the acquisition. If, on the other hand, you're looking to sell your automotive business, EBITDA will play a role in determining the company's attractiveness to potential investors.
Your Trusted Automotive Business Sales Experts
Navigating all the variables behind an automotive company's value can be a challenging undertaking. Our expert automotive business brokers at AutoCenter Sales can help you sort through the information available to get a complete picture of your investment.
Let our experts walk you through the business process and help you buy or sell your automotive business. Whether you are selling a Jiffy Lube or buying an auto shop, contact us at 1-800-874-5793 or message us online to connect with our team.