What is EBITDA and Why Does it Matter to Your Software Development Company?
November 18, 2020
There are many ways to assess your company’s financial performance, profitability, and overall financial health. One of the most common is to look at EBITDA. EBITDA stands for earnings before interest, taxes, depreciation and amortization. In other words, it’s the revenue your company brings in minus standard operating costs like salaries. It’s helpful to look at this figure since things like interest, taxes, etc. are variable and can change over time.
Just as importantly to company owners, EBITDA plays a major role in how the business is valued. It’s often used as an alternative to net income as a measure of profitability and financial wellbeing, since EBITDA is more “black and white” and less subject to interpretation than a question like, “What was your profit last year?”
EBITDA and the Exponential Increase in Company Valuation
What we’ve found in our conversations with business owners about company valuation is that even many of those who’ve heard of EBITDA don’t realize what a huge difference in value a small increase in this figure can make. That’s not surprising given that software development company principals don’t tend to have much of an accounting background. But once they understand the power that EBITDA has in determining their company’s worth, they start giving it the attention it deserves.
Consider the two scenarios below—one with a higher EBITDA and one with a lower figure.
As you can see, growing your EBITDA will result in a higher multiplier and create exponential growth in your company valuation. Consequently, any “investment” you make in better understanding and increasing this number is a good one.
Considering the Big Picture
It’s important to note, however, that while EBITDA is a useful financial measuring stick, it shouldn’t be the only indicator you monitor. Tracking and managing other numbers like cash flow, debt levels, and expenses are important and should be considered when looking at the larger financial picture of your firm.
One of the major benefits of using Factor is that it enables you to view many key performance indicators (KPIs) simultaneously. Metrics like gross margin, realized rate, and achieved multiplier are always visible to inform daily operating decisions, but they are also essential in increasing the same variables that will increase your EBITDA. Being aware of these numbers ensures that you understand the firm’s current financial status as well as the levers to pull to get to where you want to be.
Moving Beyond Keeping the Lights On
Depending on the stage of growth your business is going through, the main focus may currently be “keeping the lights on” and getting enough work coming in the door. In times of early and accelerated growth, it’s easy to ignore key financial indicators and just be happy that you have work to do.
But devoting some time and attention to understanding EBITDA and other financial metrics can be the first step in focusing your firm on the future. Factor provides the framework and tools that can help your goals evolve from completing projects to maximizing profitability.
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