How do you calculate EBITDA?
Annual profit or loss
+ Tax expenses
– Tax refunds
+ Interest expense
– Interest income
– Cleanups
= EBIT (earnings before interest and taxes)
+ Depreciation on property, plant and equipment
+ Amortization of intangible assets
= EBITDA (earnings before interest, taxes, depreciation and amortization of intangible assets)
What is the 3x EBITDA method?
The 3x EBITDA method is a very simplified form of company valuation. It means:
You get the value of your company by multiplying your EBITDA by the number 3.
Why EBITDA?
The EBITDA metric provides a good insight into the company’s profitability, independent of financing costs, taxes and depreciation.
Is 3 definitely the right multiplier?
No. The purpose of the multiplier method is to compare yourself with a similar company. Two key factors influencing the multiplier are industry and company size. Please see the monthly updated multiples overview page . But so-called soft factors, such as the company’s dependence on the current owner, extremely positive growth prospects, market position, etc. or special risk factors, such as an impending legal dispute, can also make an adjustment of the multiplier necessary.
Advantages and disadvantages of the 3x EBITDA method
Advantages
- Easy calculation and comparability : The 3x EBITDA method is relatively easy to calculate and allows for a quick comparison between different companies within the same industry.
- Focused on operating performance : Since EBITDA represents operating earnings before interest, taxes, depreciation and amortization, the 3x EBITDA method provides a clear view of a company’s operating efficiency. This method ignores capital structure and tax differences, which can vary from company to company, and instead focuses on the core business.
- Flexibility in application : The method can be easily adapted by changing the multiplier to take into account specific industry standards or market conditions. This makes the 3x EBITDA method flexible and adaptable to different situations and market environments.
Disadvantages
- Simplification and generalization : This method greatly simplifies company valuation and ignores many specific factors that can affect the value of a company. A blanket multiplier of three may not reflect the individual circumstances of a company or its industry.
- Ignores capital structure : The 3x EBITDA method does not take into account a company’s capital structure, that is, how much debt or equity the company has. Companies with high levels of debt may pose a higher risk due to interest costs and repayment obligations, which are not captured by this method.
- Overlooks investments and growth opportunities : Companies that invest heavily in growth may have lower current EBITDA but could have significant future potential. This method can overlook such growth opportunities and underestimate the value of innovative or expanding companies.
- Neglecting Depreciation and Amortization : Depreciation and amortization are important indicators of the condition and value of a company’s assets. The 3x EBITDA method ignores these costs, which can result in the wear and tear of assets not being adequately taken into account
- Failure to take tax obligations into account : Taxes are a significant cost factor for companies. The method ignores tax obligations that can have a significant impact on the net income and true financial health of a company.
- Not suitable for certain industries : The 3x EBITDA method is not suitable for all industries, especially those with high capital investments, high depreciation or volatile revenues.
- Potential misinterpretation of cash flow : EBITDA is often used as a substitute for operating cash flow, although it does not reflect a company’s actual cash flows. This can lead to misjudgments of liquidity and financial flexibility
For which industries is 3x EBITDA suitable? For which ones not?
The “3x EBITDA = enterprise value” method is well suited to more mature, stable industries with predictable cash flows, such as consumer goods, retail, telecommunications, industrial manufacturing and utilities. It is less suitable for volatile or highly cyclical industries such as technology, commodities, construction and financial services, as these industries often have unpredictable revenues and high volatility. This method is rather unsuitable for startups in general.
The “3x EBITDA = enterprise value” method can be useful as a quick and easy valuation rule, but it has significant limitations. Their use should be carefully considered and supplemented by other valuation methods to obtain a more complete picture of the company’s value.
What other rules of thumb are there?
- Depending on the industry, the 3x sales = company value or the 3x profit = company value approach may also make sense. For details, see the relevant blog posts.
- Calculate the average EBIT (earnings before interest and taxes) of the last three years. Multiply this by a factor of 4 (low value) to 6 (high value). Subtract the company’s debts from the two results. You will receive a range within which your company’s value roughly falls.
- Consider how much profit a buyer could take out of the company in the next few years. Set the price so that the purchase price can be recouped within 4 to 7 years.