Negotiating Business Value: Understanding EBITDA and Its Role

When selling a business, owners can often feel defensive about how potential buyers assess and value the company. This is understandable, as many owners have spent years—sometimes their entire careers—building a business that supports them. Receiving an offer that seems lower than expected can be difficult for an owner to accept, as it doesn’t always align with their personal sense of the business’s worth. So, how do buyers and sellers come together to agree on a fair price?

Key Factors in Determining Business Value:

Many factors play a role in determining a company's value, but one of the most critical metrics is EBITDA, which stands for Earnings Before Interest, Taxes, Depreciation, and Amortization. EBITDA focuses on a company’s primary earnings by excluding debt costs, taxes, and non-cash items like depreciation and amortization. Essentially, it measures how much money a company makes from its regular operations, without considering external financial factors.

Not only is EBITDA a useful tool for buyers in determining a business’s profitability, but lenders also rely on it to gauge whether the company can meet future debt obligations.

Why Owners Should Understand EBITDA Adjustments:

It’s essential for business owners to know how to calculate EBITDA and account for any necessary adjustments. Adjustments are typically made for non-recurring, non-operational, or unusual expenses, allowing owners to present a clearer picture of the company’s financial health. These adjustments, known as normalizations, help showcase the business's true operating performance.

For example, normalizations could include:

• Excessive owner wages
• Abnormal repair or maintenance costs
• Legal fees
• Personal expenses paid through the company

Determining a company’s adjusted EBITDA is crucial for showing potential buyers the company’s core profitability. Buyers often base their offers on a multiple of these earnings, so the more accurately an owner can present and justify their adjusted EBITDA, the better their chances of securing a higher offer.

How EBITDA Differs from Cash Flow:

While EBITDA is a useful measure of operational performance, it’s important to understand how it differs from cash flow. It provides a snapshot of how well a company is doing from an operational standpoint, but it doesn’t account for actual cash moving in and out of the business.

Cash flow, on the other hand, reflects the actual cash generated or consumed by the business over a specific period. It includes operational earnings, but also factors in:

• Changes in working capital
• Interest payments on debt
• Capital expenditures
• Taxes

In other words, cash flow provides a more comprehensive picture of the financial health of a company because it considers both operational and non-operational cash movements. While EBITDA may show profitability, strong cash flow is necessary to ensure that a business can meet its financial obligations, reinvest, or return capital to shareholders.

In summary, EBITDA gives an owner and potential buyer insight into a business's profitability, while cash flow offers a broader understanding of the company’s financial flexibility. Both are important in the negotiation process, but it’s essential not to confuse one for the other when assessing value. Determining a business's value is complex and requires evaluating multiple factors, including EBITDA, industry trends, the financial landscape, and the business's location.

For expert guidance on valuing your business, contact Alberta Business Sales today.

Jay Barrett Broker, Alberta Business Sales and Commercial Ventures