Smart business owners know to measure their company’s growth. Gone are the days when you could simply calculate your margins and profits at the end of the day and be content about it. Now, it’s all about measuring the right indicators, taking the proper aspects into consideration, and estimating your progress.
EBITDA is measuring tool that can help you understand your company’s growth. The term is an acronym whose letters stand for “Earnings Before Interest, Taxes, Depreciation, and Amortization.”
EBITDA illustrates how a company grows over time. It also gives business owners a look at their company’s growth potential.
Mainly it is a method of calculating growth that enables companies to understand if they are attracting customers or not. This measurement also shows how a company is progressing compared with its competitors. One caveat, however, particularly for small companies, is that it can make a company’s earnings appear greater than they are. This is one of the main reasons why learning how to calculate EBITDA properly is good for any company that wants to grow its operations.
Brief History of EBITDA
Billionaire landowner and businessman John Malone is credited with coining the term EBITDA. This method became popular in the business community in the 1980’s, a time many now refer to as the “leveraged buyouts era.” When investors in the 1980’s were looking for a way to assess a company’s financial position, they used EBITDA. This method helped them figure out whether a company could pay interest on loans and investments. With EBITDA, companies that were ailing financially and considered “distressed” in the market could be restructured.
Uses of EBITDA
Bankers still use this metric today to figure out a business’s debt service coverage ratio. In other words, EBITDA holds significance for business loans because it gives an insight into a company’s ability to repay its debts.
This metric also gives owners of small businesses insights into how well they are performing against other companies in their industry. Moreover, with EBITDA, they can have this comparison without doing extensive research.
The EBITDA formula provides company management with an overview of how to better manage cash flow in coming months and years. However, there is no consensus about the long-term effectiveness of the EBITDA formula for business success. Some argue that it gives a clear picture of how well a company is performing in the short term. But critics believe EBITDA can mask warning signs of a business in trouble.
EBITDA gives an idea about how a company is currently performing as well as its progress as measured against the recent past. However, this metric will not tell you much about a company’s recent or upcoming cash flow. In other words, a huge positive value with EBITDA could skew even the owner’s perception of a company’s success or lack thereof.
Despite its shortcomings, EBITDA is still a favored method of measuring business growth. This is because it allows business owners to assess their company’s progress over time. Additionally, it enables investors to think about future avenues with the company in question. So don’t use the EBITDA method exclusively, but keep it in your toolbox as a way of evaluating your company’s progress over time.