Earnings expandable section
EBITDA is a commonly used measure of earnings or underlying profit. It is calculated by adding back depreciation, amortisation and interest to the net profit, to which we then deduct dividends or drawings when assessing viability.
If your EBITDA exceeds the demands on earnings consistently over a number of trading years, then that is an indicator of viability. EBITDA is not the sole measure and has its limitations but it is a good start in the evaluation process.
There are variations on how EBITDA can be calculated, but for simplicity an example EBITDA calculation is:
| Items / Amounts | Year 3 | Year 2 | Year 1 |
|---|---|---|---|
Items / AmountsNet profit before tax | Year 3200 | Year 2300 | Year 1400 |
Items / Amounts+ Depreciation and amortisation | Year 3100 | Year 2100 | Year 1100 |
Items / Amounts+ Interest | Year 360 | Year 250 | Year 150 |
Items / Amounts- Drawings / Dividends | Year 3250 | Year 2225 | Year 1225 |
Items / Amounts(A) Adjusted Profit “EBITDA” | Year 3110 | Year 2225 | Year 1325 |
In this example over three years the EBITDA has reduced. We then need to consider the demand on the business’s earnings such as loan payments, interest, and hire purchase payments.
| Item / Year | Year 3 | Year 2 | Year 1 |
|---|---|---|---|
Item / YearInterest | Year 360 | Year 250 | Year 150 |
Item / YearBank capital repayments | Year 3100 | Year 2100 | Year 1100 |
Item / YearHP and Other Loan capital repayments | Year 375 | Year 275 | Year 175 |
Item / Year(B) Debt to be serviced | Year 3235 | Year 2225 | Year 1225 |
Surplus or Shortfall
(A) - (B) | -125 | 100 |
In this example the business's EBITDA is in decline, yet the demands on its earnings remain significant. In Year 3 there is a material shortfall.
Whist this calculation offers a guide to viability, please be aware it does not include net movements in working capital (stock / debtors / creditors), tax paid or business investment such as capital expenditure not funded on HP.
Rather than focussing on EBITDA, a more complete picture can be formed by calculating the Cash Flow available for Debt Service (CFADS) which means your EBITDA plus or minus net movements in working capital, less tax paid and capital expenditure paid (net of capital expenditure funded by asset disposals and/or hire purchase and/or finance leasing).
Financial Projections expandable section
Forward looking statements, such as projections, prepared on an integrated profit and loss, balance sheet and operating cash flow basis can, when using reasonable assumptions, support the understanding of the impact of decisions you can take within your control (such as capital expenditure or gross margin adjustment) and the impact of risk factors outside your control, such as an increase in a key cost.
