EBITDA: Explained So Simply A Child Could Understand

Imagine you are running a bakery business. Every day, customers come in to buy your delicious cookies and cupcakes – that’s your income, the money coming in. But of course, you can’t just bake with magic. You must pay for flour, sugar, rent for the shop, and even pay your bakers; it’s the money going out. 

EBITDA is a special way to see how well your bakery is doing, considering the core business of baking and selling treats. Let’s look closely at EBITDA and see how it can become your closest ally to understand how well you’re doing financially. 

What is EBITDA?

EBITDA, or Earnings Before Interest, Taxes, Depreciation, and Amortization, is a financial metric that helps you understand your business’ fundamental strengths. In the example of a bakery, the core strengths are baking and selling delicious treats.

Here’s what EBITDA excludes and why using the same example:

Interest

If you borrow money for something like a new oven, you’ll pay interest on that loan. It’s important, but interest isn’t directly tied to your daily baking earnings. EBITDA removes interest to focus only on the money you make from selling your baked goods.

Taxes

Taxes are crucial to running a business, as they’re based on your profits and can vary by location and tax laws. EBITDA excludes taxes to make it easier to compare bakeries on a standardized basis, regardless of the location.

Depreciation

Over time, your oven loses value as it gets older and less efficient. This gradual decline in value is called depreciation. EBITDA adds back depreciation because it’s not a monthly expense but a slight decrease in your oven’s worth.

Amortization

Similar to depreciation, amortization deals with intangible assets like secret recipes. As other bakeries catch on, the value of your special recipe might decline. Amortization accounts for this decrease in value over time. EBITDA excludes amortization to emphasize that your bakery’s core skill is baking and selling, not your secret recipe.

Why is EBITDA Important?

Let’s take the same bakery example and Imagine you’re choosing between different bakery franchises. Now, you won’t pick the prettiest one; you want to know which bakery will most likely succeed. That’s where EBITDA becomes useful.

Fair Comparison

Bakeries can have different tax rates or recently borrowed money for big purchases like new ovens. When you look at net income (profit after all expenses), these things can skew their actual earnings. EBITDA evens out these differences, giving a clearer picture of which bakery is best at making money from baking and selling. 

According to CFI, investors often use EBITDA multiples (a company’s value divided by its EBITDA) to value businesses, making a strong EBITDA even more crucial for bakeries seeking investment. 

Focus on Core Business

EBITDA helps you focus on how well the bakery is doing rather than how it manages debt or tax strategies. It focuses on the baking side and helps you judge a bakery’s potential for growth based on its sales.

Final Thoughts 

EBITDA is like a special tool to see how your bakery is doing – baking and selling.  It helps you compare bakeries fairly and understand their core earning power.  You must also know that EBITDA isn’t the only thing to consider. A bakery could have a high debt but still be profitable if they make a lot from baking. But, EBITDA is a great tool for quickly understanding how well a bakery makes money from its core business.