Mergers and acquisitions are a serious business with a lot at stake. You have to decide which companies to buy, how much to pay, and when to sell based on the company’s financial health. Getting wrapped up in the details is easy when you’re looking to buy a business. However, if you don’t understand how the firm makes money, you could be setting yourself up for failure. One of the first things Investors look at when buying a business is its earnings before interest, taxes, depreciation, and amortization (EBITDA).
What exactly is EBITDA
EBITDA calculation measures a company’s profitability by excluding the cost of borrowing money and paying taxes. It also determines whether a business generates enough cash flow to qualify for additional financing. It is also known as “cash flow from operations.” A regular income statement does not consider depreciation and amortization expenses.
A proven mergers and acquisition strategy
The EBITDA calculation reflects the operating profitability of a business, making it easy for owners, investors, and stakeholders to make comparisons with similar firms. Thus the EBITDA is often preferred over other metrics when developing a mergers and acquisition strategy. The approach also helps you determine which businesses are good acquisition candidates.
Profitability without distortions
Earnings before interest, taxes, depreciation and amortization (EBITDA) are often used as a valuation metric to compare businesses because they remove the profit distorting effects of accounting choices such as depreciation methods or tax rates. The EBITDA calculation is also helpful because it shows you the cash generated by your business before considering any debt obligations or tax burden from the government. This allows you to determine if your venture will succeed even after acquiring another company or merging with one.
Negotiate better terms
The EBITDA approach removes the profit-distorting effects of interest income and taxes. Using this approach, you can quickly determine whether a company can service loans and debts. It helps widen the net profit margin of your business, thus allowing you to negotiate better terms with suppliers, creditors, and buyers.
Valuate potential acquisitions
You can use the EBITDA calculations as an acquisition strategy to determine whether a company has sufficient cash flow to succeed in its operations. The approach also helps you determine if there are any hidden costs or expenses that sellers or buyers of a business have overlooked.
Compare the business to competitors
The EBITDA calculation allows you to compare your business performance with other companies in your industry. Comparison will help you determine whether your business is going in the right direction or needs significant structural changes. It is a valuable tool when negotiating a merger plan.
Get your merger right
By using EBITDA calculation as a merger and acquisition strategy, you can see how a potential merger or acquisition will affect your company’s overall profitability. Using EBITDA to determine incomes and profitability helps remove the profit-distorting effects of interest income and taxes. You can use EBITDA as a merger and acquisition strategy, thus allowing you to determine the viability of the new venture.
Story by Brad Bernanke
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