What is EBITDA in business?
EBITDA stands for Earnings Before Interest, Taxes, Depreciation, and Amortisation.
It is a financial metric used to assess a company’s operational performance by focusing on earnings from core business activities, excluding the effects of capital structure, tax regulations, and non-cash accounting items.
How Operating Income, Expenses, Cash Flow and EBITDA Tie Together for a Small Business Owner
Understanding how operating income, expenses, and cash flow tie together is very important for managing a small business in Australia effectively.
Operating income
Operating income, or operating profit, is the earnings from core operations after subtracting operating expenses like rent and wages.
For instance, if your coffee shop makes $10,000 in sales each month and you spend $6,000 on rent, wages, and supplies, your operating income is $4,000. This shows how profitable your core business activities are.
Net income
Net income includes all expenses, such as interest and taxes, providing a complete profit picture.
If your coffee shop’s operating income is $4,000, but you have $500 in loan interest payments and $300 in taxes, your net income would be $3,200. The net income reflects the total profit after all costs are considered.
Depreciation and amortisation
Depreciation and amortisation are non-cash expenses reflecting asset value reduction over time.
If you bought a coffee machine for $12,000, and it’s expected to last 4 years, you would depreciate it by $3,000 each year. This doesn’t affect your cash flow directly but helps track the asset’s value reduction.
Cash flow
Cash flow is the money moving in and out, ensuring you can cover daily expenses and invest in capital expenditures.
If your coffee shop receives $10,000 in sales and you spend $8,000 on supplies, rent, and wages, your cash flow is $2,000. Positive cash flow means you have funds available for unexpected expenses or investments like new equipment.
EBITDA for Small Business Owners
EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortisation) further refines this view by focusing on operational profitability, excluding non-operational factors.
For Australian small business owners, like coffee shop owners, keeping an eye on these metrics helps make informed decisions, maintain positive cash flow, and ensure long-term business health.
How to calculate EBITDA?
To do the EBITDA calculation, you start with the company’s net income and then add back the interest, taxes, depreciation, and amortisation expenses. The EBITDA formula is:
EBITDA = Net Income + Interest + Taxes + Depreciation + Amortisation
In this EBITDA formula, here is what each item stands for:
Net Income
The profit of the company after all expenses, including interest, taxes, depreciation, and amortisation, have been subtracted from total revenue.
Interest
The cost incurred by the company for borrowed funds. Adding this back removes the effects of the company’s financing decisions.
Taxes
Government-imposed charges on income. Adding back taxes allows for comparison between companies with different tax obligations.
Depreciation
The reduction in the value of tangible fixed assets over time. Adding this back excludes the impact of capital expenditure.
Amortisation
The process of writing off the cost of intangible assets (like patents) over their useful life. This is added back to focus on operating performance.
Example of EBITDA calculation
So, how should you be calculating EBITDA? For instance, if a company has the following financials for a year:
- Net Income: $200,000
- Interest: $50,000
- Taxes: $30,000
- Depreciation: $20,000
- Amortisation: $10,000
The EBITDA calculation would be:
$200,000 + $50,000 + $30,000 + $20,000 + $10,000 = $310,000
What is EBITDA Margin?
EBITDA margin measures a company’s profitability which shows how much of its earnings, before interest, taxes, depreciation, and amortisation, is generated as a percentage of its total revenue.
How to calculate EBITDA Margin?
To calculate EBITDA margin, you divide the EBITDA by the total revenue and multiply by 100 to get a percentage. For example, if your coffee shop has an EBITDA of $50,000 and total revenue of $200,000, your EBITDA margin would be:
EBITDA Margin = (Total Revenue / EBITDA ) ×100
In the current example, that would be:
(200,000 / 50,000) × 100 = 25%
A higher EBITDA margin indicates a more profitable business with better control over its operating costs.
What is Adjusted EBITDA?
Adjusted EBITDA takes the standard EBITDA calculation and adjusts for non-recurring expenses and incomes that are not part of the regular operations of the business.
This could include costs like one-time restructuring costs, or earnings from the sale of equipment. It provides a clearer picture of the company’s ongoing operational performance by excluding these unusual items.
How to Calculate Adjusted EBITDA?
To calculate Adjusted EBITDA, start with the regular EBITDA figure and add back (or subtract) any identified adjustments.
For example, if your coffee shop has an EBITDA of $50,000 but has a one-time expense of $5,000 for a legal settlement, your Adjusted EBITDA would be:
Adjusted EBITDA = EBITDA + One-time Expenses = 50,000 + 5,000 = 55,000
Why is EBITDA important?
The EBITDA calculation is a key indicator of a company’s financial health as it strips away the effects of financing and accounting decisions, providing a clearer picture of operating performance.
It is often used by investors and analysts to compare profitability between companies and industries as it neutralises the differences caused by varying tax rates, capital structures, and fixed asset accounting.
Why EBITDA Matters for Small Businesses in Australia?
For a small business in Australia, keeping an eye on your company’s EBITDA and EBITDA margin is crucial. These measures help you understand how well your business is performing in terms of core operations. It’s a way to measure your company’s operating performance.
A good EBITDA margin indicates efficient management of operational costs and better profitability, which can attract investors or make it easier to secure loans.
Additionally, using Adjusted EBITDA can give you a clearer picture of your business’s true profitability by filtering out unusual expenses. This helps in making informed decisions about cost management and strategic planning.
For instance, if you see that your adjusted EBITDA is improving over time, you might decide to invest more in marketing or expand your menu.
Regularly monitoring these financial metrics can help you manage your coffee shop more effectively, ensuring long-term sustainability and growth. Keeping these in check means you’re not just surviving, but thriving in a competitive market.
How to make sure you’re doing EBITDA right
To ensure accurate EBITDA calculations are accurate, here are a few tips:
- Use consistent and reliable financial data.
- Clearly distinguish between operational expenses and interest, taxes, depreciation and amortization expenses.
- Regularly review and adjust your calculations to account for any changes in financial reporting standards or business operations.
Need help with other finance or bookkeeping questions?
At First Class Accounts we have an extensive network of nationally accredited bookkeepers that spans across every suburb and town in Australia.
We help business owners to make informed and timely decisions that affect their operational efficiency, control, cash flow and profitability. Here is how we do that:
- Over 150 franchises across Australia.
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Our experienced bookkeepers are ready to help your business thrive. Contact us today and see how we can support your financial goals. Or you can check out local bookkeepers near you here.