An MSPs Guide to EBITDA and Why It Matters
Your MSPs EBITDA is a critical metric for understanding and communicating your company’s worth. But what is it? How do you calculate it? And why should you even bother with understanding EBITDA in the first place?
- It’s always better to calculate the value of your MSP using EBITDA. This method makes it possible to measure the performance of the company without having to factor in tax environments and accounting
- Calculating EBITDA is pretty simple and gives you an idea of how potential buyers may value your company and compare it to others in the field
- Business owners use EBITDA to measure many things, including growth trends, profitability, and overall company performance
You may have heard that the best way to build a company is to build it as if you intend to sell it. And for that reason, you may already be wondering how much your MSP is worth at this point.
There’s no shortage of methods to measure the value of a business. However, most of these ideas fail to account for all the details of your MSPs particular solution, and you may find yourself a little disappointed when you make it to the negotiating table and hear what buyers are willing to shell out for your MSP.
EBITDA is one metric that has been shown to reliably measure a company’s overall performance, profitability, and ability to pay its debts.
What is EBITDA?
EBITDA stands for earnings before interest, taxes, depreciation, and amortization. It is a measure of a company’s overall financial performance and can work as an alternative to net income in some cases.
Some of the drawbacks of EBITDA include the fact that it does not take into account capital expenditure. So, it does not account for investments like equipment, property, and plants, as well as the expenses associated with debt and taxes. However, many experts still consider it a great measure for corporate performance and comparison because it measures earnings before cuts associated with accounting and other fiscal obligations.
Perhaps the best way to look at EBITDA is as an estimate of a company’s profitability or the amount of cash flow available to pay off debts associated with long-term assets. This is one of the reasons why buyers will want to talk about your EBITDA if you decide to sell your MSP.
Formula for calculating EBITDA
Understanding EBITDA gets easier once you learn the formula for calculating it, which is pretty straightforward. It uses information that can easily be gleaned from a company’s balance sheet and income statement.
EBITDA = Net Income + Taxes + D + A
D = Depreciation
A = Amortization
Sometimes this EBITDA formula is simplified to this:
EBITDA = Operating Profit + DE + AE
DE = Depreciation expense
AE = Amortization expense
The fact that EBITDA does not consider factors that vary from one industry to another — like taxes and interest rates for example — is the reason many consider it great for “apples-to-apples comparisons.” It’s an accurate way to compare the performance of companies operating in different industries.
Factors that affect your MSPs EBITDA valuation and overall value
The fact that buyers and investors pay attention to EBITDA makes its formula important to know. It gives you an idea of the metrics that are vital to the growth and valuation of your MSP.
Understanding EBITDA may make you more interested in the following factors:
- Net profit percentage: Generally speaking, companies with higher percentage profit will be valued as higher multiples of EBITDA than companies with lower percentage profit. A company’s value is sometimes calculated as a multiple of EBITDA (10x, 5x, 2x, etc.)
- Total profit: An MSP that, say, generates $1M of annual EBITDA would naturally enjoy valuations of higher EBITDA multiples than one that generates $500,000 of annual EBITD
- Trajectory: Sometimes, companies with the same EBITDA may be valued differently because of different growth rates. Companies with demonstrably higher bottom-line growth rates will be valued higher than companies with the same EBITDA but slower growth trajectories.
- Location: Sometimes, buyers place a high value on the market your MSP serves. For example, local buyers may be more invested in your local market than one operating in wider or foreign markets.
- Customer base: This is a tricky feature to deal with because customer base depends on a lot of factors, including percentage contribution to monthly recurring revenue (MRR), location, and income size, among others.
- Revenue makeup: Buyers are more likely to pay attention to businesses with a large percentage of MRR than with companies with more non-recurring revenue. It’s important to get your clients locked in and invested for the long term.
If you do intend to sell your MSP one day, or you see that as a possible but remote goal at this point, you should keep an eye on intangibles that EBITDA doesn’t take into account. For example, your management team, brand, and quality of client contracts can greatly influence how your company gets valued.
Take the time to talk to prospective buyers in your industry about what they are looking for in MSPs and add that information to your understanding of EBITDA.
WHY is EBITDA important for your MSP?
Assuming you don’t intend to sell off your MSP one day and ride off heroically into the sunset, there are still lots of reasons why you should invest in understanding EBITDA:
- EBITDA offers a clear reflection of company processes because it strips away expenses that normally obscure company performance.
- EBITDA can be used to analyze and compare profitability between companies, even if they operate in different industries. This works because it takes away the effects of financing and capital expenditures. EBITDA is often used in valuation ratios and is compared to revenue and enterprise value for this very reason.
- EBITDA can show investors or buyers that a lack of profitability may be due to debt or taxes since these are added back in its calculation. This is more reason why you may want to have it on hand when talking to investors or buyers.
- Early-stage companies may find EBITDA handy when communicating with investors and analysts since companies of this age and size tend to use depreciation and amortization accounts to expense the cost of property, plants, equipment, and capital investment.
- EBITDA can sometimes be taken as a growth metric when expense accounts associated with capital are left out. When this happens, EBITDA gives valuable insight into growth trends and profit.
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