A financial ratio relating the value of a business to its earnings before interest, taxes, depreciation and amortization expenses.
What It Means
EBITDA valuation multiple is a common choice in valuing businesses using the market-based valuation methods. The multiples are ratios that are statistically derived from recent comparable business sales.
Once the price the business sells for is known, you can divide it by the firm’s most recent annual EBITDA figure. Repeating the calculation for a number of comparable companies gives you a statistical population. The valuation multiples can thus establish a range, from low to high, as well as the average and median values.
You can estimate the value of a company in the same industry sector and with similar financial and operational attributes using the EBITDA valuation multiples. For example, to calculate the expected value of your business, multiply the company’s recent EBITDA earnings by the average valuation multiple.
EBITDA valuation multiple factors out the following elements when estimating the business enterprise value:
- Business taxes
- Effect of capital structure used to finance business operations
- Cost recovery of the investment in fixed business assets
Meaning of EBITDA adjustments in business valuation
These adjustments help you put your business valuation on a level playing field.
Many privately owned businesses are structured as pass through entities and do not pay taxes, hence the tax addback.
Business owners have considerable discretion in how to finance the operations. This is reflected in the addition of interest expense to the EBITDA earnings basis. As a result, you can determine the value of the company regardless of the choice of capital structure.
Management may opt for quick cost recovery on fixed assets and depreciate them even if the assets retain considerable economic value. Company net income may be artificially low due to high depreciation and amortization expenses. Selecting EBITDA as the earnings basis for your business valuation lets you capture the true economic potential of the firm.
Types of businesses valued using EBITDA valuation multiples
EBITDA valuation multiples are especially well suited for appraisal of asset rich companies including:
- Manufacturing businesses
- Distribution and wholesale firms
- Real estate driven companies
- Technology businesses