How is EBITDA used to value a business, and what does the multiple mean?

What is an EBITDA multiple? EBITDA stands for earnings before interest, taxes, depreciation and amortization, and the Business Development Bank of Canada says it helps evaluate a business’s core profitability. The multiple is the number EBITDA is multiplied by. BDC calls applying a multiple to EBITDA a common valuation method for determining how much a business is worth. The term itself is explained in the EBITDA glossary entry.

How the figure is built

BDC says EBITDA is calculated by adding interest, taxes, depreciation and amortization back to net profit. The multiple then multiplies that result, so the arithmetic has two inputs. BDC notes that after due diligence the parties may revise the offer price based on an adjusted EBITDA or a different multiplier, and that adjusting EBITDA aims to remove one-time and extraordinary items not connected to core operating profit. That is one reason a business can show different numbers, as discussed in why the same business shows two different EBITDA numbers.

What the number leaves out

BDC calls EBITDA a good shortcut to a quick picture of available cash flow, and also says it does not account for non-operating expenses such as interest on debt, taxes and other costs. A multiple applied to it inherits that gap. If you are the buyer, ask what the business needs to spend on equipment and what debt it carries, since neither is visible in EBITDA alone.

Where a quoted multiple comes from

BDC’s valuation glossary lists, among market-based methods, looking at the sales prices of comparative firms that have been recently sold to determine the multiple of earnings that was paid. BDC’s article on company valuation adds that the figure used varies with factors such as industry, company size, market conditions and multiples used to buy or sell comparable businesses. Ask where a multiple came from, how similar those businesses were, and when they sold.

A method input, not a valuation

BDC says it helps to hire a chartered business valuator, and that a valuator’s figure is only a guideline for approaching negotiations. Treat any multiple you see as an input to that conversation, not as a conclusion. For a different earnings measure, see SDE vs EBITDA.