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Meaningful Metric February 2021 | The Enterprise Value (EV)/EBITDA Multiple

February 23, 2021
| By: Dan Schlimm

If you are selling your business, you must understand this basic metric. 

All too often, business owners focus solely on net earnings multiples quoted by various M&A  providers, and ignore the underlying assumptions on business debts, transaction terms, risk factors, synergies and growth rates. The common perception is that if one company is worth x times its earnings, then so is mine.

The Enterprise Value (EV)/EBITDA ratio is a popular metric used as a valuation tool to help with comparisons.  Most business valuations assume a transfer of a company on a debt free basis. 

The enterprise-value-to-EBITDA ratio is calculated by dividing EV by EBITDA. The lower the EV/EBITDA, the cheaper the valuation for a company.

EV = Purchase Price + Any Debt Assumed – Cash On Hand

EBITDA = Net Earnings + Interest + Taxes + Depreciation/Amortization

Generally speaking, EV/EBITDA values below 10 are seen as healthy and most useful when comparing relative values among companies within the same industry.

There are many pros and cons to using this ratio. As with most figures, whether it is considered a “good” metric depends on the specific situation.

Pros include:

  • Easy to calculate with publicly available information
  • Widely used and referenced in the financial community
  • Works well for valuing stable, mature businesses with low capital expenditures
  • Good for comparing relative values of different businesses

Cons include:

  • May not be a good proxy for cash flow
  • Does not take into account capital expenditures
  • Hard to adjust for different growth rates
  • Hard to justify observed “premiums” and “discounts” (mostly subjective)

Experienced CFOs, like the partners in the Florida CFO Group, can help you evaluate, negotiate and execute buy/sell transactions that meet or exceed your expectations. Contact Dan or one of our other partners to discuss how we can help.

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