March 2023

Short, Sweet and Super Important (Part 2)

Andy Acton of Frank Taylor & Associates continues his explanation of the importance of understanding your business’ EBITDA.

‘We’ve already discussed why understanding the underlying financials are a key part of our valuation process. I’d hesitate to say that ‘the devil is in the detail’ as the calculations aren’t fiendishly complicated, but it is important to understand what items are excluded from (or included in) the EBITDA calculation and why’.

‘Non-operating income, put simply this is income the business gets that isn’t generated by its normal operating activity. For example, in the case of a dental practice, interest earnt on a deposit account balance wouldn’t be included in the EBITDA; the clue is in first part of the name, the “EBI bit’ means earnings before interest. It’s really because the practice’s core business is to provide dental care to its patients, not to invest funds or ‘play the markets’.’

‘One-off revenues or expenses, whilst these are unavoidable from time to time, the very fact they are unusual means they aren’t part of the day-to-day underlying costs or revenues for the practice and should be excluded from EBITDA. Typical items in this category might be legal or restructuring costs and it could be argued that some of the costs incurred during the COVID pandemic to enforce social distancing in a practice, or indeed any commercial premises, such as the installation of perspex screens at counters and tills, are one-offs. They were necessary to keep the business going but won’t be regular annual costs as, we hope, the pandemic was a once in a lifetime event.’ 

‘The write-down of an asset. This may arise if an asset, for example a piece of technology, has become obsolete as newer models have overtaken it. When this happens the accountant would reduce the value of the asset to the business by writing it down, which is ‘finance speak’ for recognising it’s worth to the business is no longer what it was. It’s effectively an acceleration of the depreciation and again the clue is in the name (the “D” of EBITDA is depreciation). Again, if this is necessary, the write-down isn’t indicative of the health or otherwise of the practice, merely acknowledgement of technological advances and is just a booking keeping entry rather than a cash payment.’

‘Another example, and often key in practice sales and purchases, is the treatment of goodwill. Goodwill is the value of the business over and above the value of its physical or tangible assets (building, furniture, machinery e.g.). The reduction in the value of goodwill can be recognised by amortising it, which really means reducing its value over a period of time. Much like the write-down of an asset, amortising this goodwill is really only a bookkeeping entry, and not part of our EBITDA calculation (it’s the “A”).’

‘Also worthy of consideration is the compensation for the owner of a business. In private companies, owners often pay themselves more than a comparable executive role would pay an employee. A buyer will usually adjust the owner’s salary to the market ‘norm’ and as a result the EBITDA calculation will need to be amended to reflect this.’

‘Whilst this isn’t an exhaustive list, I hope it captures the more commonplace items that the calculation needs to accommodate. If you want help in getting a professional valuation of your practice, call us on 0330 088 1156 for further advice.’