I have talked to business owners a lot about this term EBITDA, and they look at me with a puzzled look. It’s not either heard it before, or they don’t know what it means. EBITDA is an acronym. It stands for earnings before interest, taxes, depreciation, and amortization.
When you’re comparing your business against another business, you want to compare your EBITDA rather than your profits against theirs or the benchmark. The reason is that every business has a different taxation level. Some have depreciation, or amortization, or both. Others have loans in which they pay interest. All of those things distort the bottom line. So, we remove all those things, interest, depreciation, taxes, and amortization, to look at the true picture of business profitability.
When we run financial statements for our business, we run them and we look at the profit, the net income of the business. Then the line after that is EBITDA. We look at it every month and every year.
Very frequently, when you begin in business, you don’t make a profit for a while, this is something I call the “flywheel effect.” My observation is most businesses may have cash flow in the first two or three years of their life, but they don’t have true profits. That’s something you build over time.
You want to have a goal, not just for net income, but EBITDA. Because again, as you grow your business, you’re going to have more depreciation or amortization. Perhaps you’ll borrow money as you go. It’s important from the very beginning, to use this measure because it’s the thing that will tell you from the first day to the last of your business, how you’ve done and how you can compare yourself against prior performance.
We compare ourselves and every business that I own against other businesses that are similarly situated in our part of the country and roughly our same size. Those benchmarks, if you will help us to know how we’re doing against our peers. Benchmarking is wonderful because frequently you can see, are you trying to make a lot more profit or EBITDA, or are you trying to grow faster? You can’t make as much profit, or EBITDA, when you’re growing rapidly as you do when you’re focused on just the bottom line. So, it’s important to know what your business goals are, and then compare yourself against your performance in the past, your goals for the future, as well as other people in your industry.