EBITDA valuation method definition
/What is the EBITDA Valuation Method?
The EBITDA valuation method is used to derive a possible sale price for a business. This method approximates the cash flows generated by an organization, which are then used as the basis for a valuation calculation. The name is a contraction of the term Earnings Before Interest, Taxes, Depreciation, and Amortization. To employ EBITDA to value a business, look at other organizations in the same industry that have sold recently, and compare their selling prices to their EBITDA information. This yields a multiple of selling prices to EBITDA that can be used to arrive at a general estimate of what a company is worth. The outcome of this analysis is likely to be a range of values, since the prices of the companies that were sold will vary, possibly by substantial amounts.
How to Calculate EBITDA
The formula for EBITDA is to add back to a firm’s earnings its interest, taxes, depreciation, and amortization. The formula is as follows:
Earnings + Interest + Taxes + Depreciation + Amortization = EBITDA
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Example of the EBITDA Valuation Method
The president of ABC International wants to gain a general understanding of the valuation of his business, and so compares the selling prices of similar companies to their EBITDA information over the past year. The result yields a median multiple of 5x. Since ABC currently generates EBITDA of $2,000,000, this means that a valuation of $10,000,000 could be ascribed to the business.
Problems with the EBITDA Valuation Method
There are several reasons why the EDITDA valuation method must be considered only a very general approximation of valuation. These reasons are:
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Other acquirers may have other reasons than cash flow for paying whatever prices they paid for companies in the list of recent acquisitions. For example, they could have paid a high price to secure a valuable patent, or a low price to acquire a bankrupt business.
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The EBITDA concept does not exactly match cash flows, since it does not account for fixed asset expenditures or a number of accruals .
Given these issues, an EBITDA valuation should be one of several valuation methods used, and may only provide a general understanding of roughly the type of valuation that the owners of a business can expect to receive.
