By Brad MacLiver
EBITDA is an acronym for earnings before interest, taxes, depreciation and amortization and is often used to measure the value of some businesses. It can also be used in the comparison of similar companies.
Generally, EBITDA makes it easier to evaluate various companies and to compare them against industry averages by removing the non-core and irregular operating costs, such as interest, which can vary depending on the management’s choice of financing, taxes which can fluctuate depending on acquisitions or losses from prior years, and arbitrary factors of depreciation and amortization.
The EBITDA formula can be used as a guideline when valuing larger companies, or when comparing the profitability of large similar companies in the same industry.
For the effective use of EBITDA, these larger companies should possess significant assets, have heavy amortization schedules, or bear substantial amounts of debt. Considering independent pharmacies in
EBITDA is derived by: 1. First calculating net income by obtaining total income and subtract total expenses.
2. Determining the total amount of taxes paid to local, federal, and state governments.
3. Establishing interest fees paid to individuals or companies for the use of credit or capital.
4. Determining depreciation expenses, which are expenses recorded to allocate a tangible asset's cost over its useful life.
5. Calculating amortization expenses, which are expenses for the consumption of the value of intangible assets over a specific period of time or the asset's expected life. These assets include goodwill, copyrights, and patents.
6. Add the values from #1 through #5.
EBITDA calculation example:
1. Net Income 2,050
2. + Taxes paid 610
3. + Interest Expenses 407
4. + Depreciation 240
5. + Amortization 102
6. = EBITDA 3,409
There are some drawbacks to EBITDA: 1. The number can be misleading when it is confused with cash flow.
2. It can also make even completely unprofitable firms appear to be financially healthy.
3. It it too easy to manipulate the numbers.
4. This value can overlook cash requirements for growth in accounts receivable.
5. It can also miss cash requirements for growth in inventories.
6. When valuing small companies, EBITDA is not factual number.
7. This number is ineffective for companies with few assets, small amounts of debt, or low depreciation or amortization schedules.
In the past, EBITDA was used as a proxy for cash flow in leveraged buyouts to calculate whether companies could service their debt. Factoring out interest, taxes, depreciation, and amortization can allow an unprofitable business to appear financially healthy. This method of valuation was used extensively during the dotcom era to value unprofitable businesses, with few assets, little earnings, and the results from that method caused many to go bust. This was a blaring example of misapplying EBITDA.
Knowledgeable North Dakota pharmacy specialists performing pharmacy business valuations will use EBITDA in pharmacy valuations, but only as part of a larger formula when computing values for specialty pharmacies in
The EBITDA number for a specific existing
Buyers may not have the same tax base, interest expense, or the same depreciation schedule, thus it is important that the buyer calculate an estimated EBITDA that is specific to their operating model, business systems, buying power, cost of operations, etc., not the sellers. It should also be noted that EBITDA assumes that the buyer will acquire all of the assets, working capital, accounts receivable, and liabilities. Those assumptions do not hold true regarding an acquisition of a pharmacy in
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