The life blood of any business is its ability to generate solid cash flow. Without positive cash flow, a company will eventually go out of business. This TIP will focus on one of four key pillars that drive cash flow. In this case we will look at “Earnings Before Interest, Taxes, Depreciation, and Amortization,” or more commonly known by the moniker EBITDA.
Where do you find this metric? One of the financial statements that you can get from your accounting system is the profit and loss statement. The very last number of this statement is typically labeled “net income.” Net income is the profit you have left over after paying all your expenses. When we add back to net income the interest expense, depreciation expense, amortization expense, and income tax expense we get the number for EBITDA.
EBITDA formula:
Net income +
- Interest expense
- Depreciation expense
- Amortization expense
- Income tax expense
= EBITDA
EBITDA is important for two reasons:
- It is a general indicator of your company’s ability to generate cash flow from the operations of your business
- It is used as part of the formula for valuing a business. Often someone who wants to buy a business will value it based on a “multiple” of EBITDA. In other words, they are buying your company’s ability to produce cash flow now and into the future.
To generate positive cash flow, you need to have a positive EBITDA. Otherwise, you are generally finding yourself starting your cash flow conversation in the negative position and will likely need to borrow money or find investors to provide capital to keep the company going.
Start with a positive EBITDA number and you can be more confident with your company’s ability to generate positive cash flow. Do you know your EBITDA?
Let us know if we can help you with this important metric.