Let’s take the topic of EBITDA Earnings Before Interest Depreciation and Amortization and contrast it with Cash Flow. EBITDA is objective financial data that is more frequently utilized in large transaction where the financial data of the business reflects an EBITDA number of $500k or more. This is the domain of private equity investors seeking transactions in what we call “Mergers & Acquisitions”, these are privately held businesses that are financially solid and growing where the seller is seeking an exit strategy or private equity funds to grow the business. Typically, gross revenues exceed $5 million to $10 million dollars. This is a robust market that has numerous private equity funds seeking out businesses in specific industries that they focus on or require financial strength as described above in order for them to investigate the transaction. They will consider “add-on” businesses which are smaller companies not necessarily meeting their financial criteria but in a similar industry that they are invested in which would compliment or “add” additional value to their existing portfolio.
Cash Flow becomes a little more subjective. Cash Flow is EBITDA plus things like owner’s compensation adjusted to reflect the cost of hiring someone to replace the existing owner’s function in a business. In a smaller business, not meeting the criteria for an M&A transaction, Owner’s salary is 100% added back as it is the position of Business Brokers involved in these transaction that they are selling an “owner operated” business. Therefore, EBITDA plus adding back owner’s salary reflects potential Cash Flow a prospective buyer can expect coming out of the business to them as long as they “operate” the business themselves and take out some level of compensation. More later – Dan