Fundraising financial acronyms getting you into a pickle with investors?!
EBITDA is a financial acronym that founders should know about – it is the measurement to determine whether your business can repay its debts. At the height of the leveraged buyout era in the 1980s, this method of measuring a company became popular.
For full breakdown of all of the acronyms within a financial model, plus guidance on how to present each section, FundingHero have got you covered…. You just need access to our FREE Financial Model Canvas. (Sign up here to access)
In this article we discuss EDITDA in a little more detail to get a better grasp of this term and why it matters in the world of start-up fundraising. But first, let’s look at the financial model as a whole.
What is a Financial Model?
The financial model of a business is an important instrument for funding success. When seeking early-stage investment, it’s critical to demonstrate to potential investors that you, as a founder, understand your company’s major revenue and expense drivers.
The subject of financial models is one of the most major headaches that founders face while planning to finance. Let’s speak about what your model should include and, more significantly, why you need one.
The financial model of your start-up company offers potential investors what they want to see. While it can be time-consuming, the process of developing a financial model benefits teams by forcing them to think carefully about their assumptions, pricing models, growth rates, and risk considerations. Furthermore, financial modelling demonstrates to investors that you are targeting a large enough market. Creating an economic model is also a wise technique to plan the quantity of cash needed.
Now, Let’s look at just one of the sections from the Financial Model a little closely together for better understanding:
Section 5 of the Financial Model Canvas – EBITDA (We break down the financial model in sections so it’s easier to complete)
The objective of EDITDA is to explain how the EBITDA (profitability) evolves over time.
E-BIT-what?
EBITDA is your trading profit after your overheads are dedicated from your gross profit. EBITDA (pronounced “ee-bit-dah”) is a metric used by investors to assess the performance of a company.
The full acronym is Earnings before interest tax depreciation & amortisation (EBITDA)!
Quite the mouthful, right! But you need to understand it as this is the key profit measure investors and business owners talk about as its the profit from pure operations before considering the various financing costs such as interest and tax.
It’s an expectation of what profit you should expect to turn into cash, so for this reason it is the key profit metric you need to report on and talk about with a clear understanding.
When you know what this is, you can then explain your path to profit and breakeven.
How do you calculate EBITDA?
EBITDA can be calculated in two ways:
1) By including depreciation and amortisation in operating profit (EBIT) By including interest, tax, depreciation, and amortisation in net profit
2) To use EBITDA, you must first understand what each component of the formula means.
EBITDA is a reliable indicator of the amount of money a company can yield before incurring overhead costs.
Why does EBITDA matter when I’m seeking external investment for my start-up?
EBITDA is used by investors and business owners to compare companies in the same industry. EBITDA is one of the most important metrics that investors consider when buying or selling a company. The primary concern of many startup investors would be ensuring that the company had an audited, up-to-date EBITDA analysis.
The key reason to understand your company’s EBITDA is to assess its overall financial health. EBITDA is a critical metric for determining a company’s profitability. It is also an important indicator of a company’s ability to generate cash and service its debt. Understanding a company’s EBITDA allows you to gain a better understanding of its overall financial stability and make better investment decisions.
What else can I use EBIDTA for?
The following business activities benefit from EBITDA:
Budgeting: Assume you’re planning your company’s budget for the coming year and want to know if you can afford to upgrade your machinery. With EBITDA, you’ll have a good idea of your company’s financial health and will know when to add the extra expense.
Downsizing: If downsizing staff appears to be necessary, but you’re torn between letting employees go and weathering the storm, an EBITDA analysis will help you make that decision objectively, rather than subjectively.
Investing: Let’s say you’re interested in a company and want to become an investor. The EBITDA can help you understand whether or not the company has strong growth potential, especially when compared to other companies, so you can decide whether or not it is worthwhile to join the team.
Developing an exit strategy: If you’re ready to retire and want to sell your company, an EBITDA analysis can demonstrate to buyers that it’s a wise investment and help you set the right asking price.
How do you go from losing money initially to making profit?
Your path to profit is a fundamental narrative that you will need to understand and be able to communicate with clarity.
This is one of the key moments where you show investors that firstly you know what path to take to get to profit and secondly what key actions you need to do to get there.
If you do this well then you’ve done what a lot of founders struggle with and investors will appreciate your financial awareness.
Are there any limitations in EBITDA that I need to know about?
One limitation of EBITDA is that it excludes debt service and capital expenditures. Analysts frequently look at free cash flow to get a more accurate picture of a company’s financial health, which is calculated as EBITDA minus capital expenditures.
One other restriction of EBITDA is that it does not account for changes in working capital. For example, if a company’s accounts receivable have increased significantly, this will not be reflected in EBITDA.
Once again, EBITDA can be misrepresentative when a company’s earnings are affected by one-off items that directly affect the earnings. For instance, if a company is selling a division, the gain will be reflected in EBITDA even if the company’s operations have not changed.
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