Dollars & Sense
Why it’s important to understand your EBITDA
BY Robert Lillegard
But that’s a mistake, especially when it comes to financial planning. Spending a little time tracking your cash flow now can mean the difference between success and failure later. And while accounting can get extremely complicated, a simple formula called EBITDA can tell you much of what you need to know.
First things first. EBITDA stands for “Earnings Before Interest, Taxes, Depreciation, and Amortization.” It’s basically your gross revenue minus your food costs, payroll and other expenses, with the four expenses mentioned above added back in. EBITDA is a basic measure of cash flow that would be available to a debt service. According to Brian Murphy, vice president of business banking at the Duluth, Minnesota-based North Shore Bank of Commerce, it’s crucial if you’re interested in getting a loan.
“It’s critical,” Murphy says. “It’s one of the most important calculations that we do as bankers. What we’re trying to do is determine capacity to pay.”
So how can a restaurateur learn their EBITDA? Murphy says the answer is probably already in front of most of them.
“It’s right in the financial statements,” Murphy says. “That’s the first good piece of advice — keep good financial statements.”
Even if you don’t read your financial statements, it’s still good practice to keep them for the bank. Pete Radosevich, who owns Eskomo Pizza Pies in Esko, Minnesota, says that he couldn’t tell you his EBITDA offhand, but he’s able to get it when it counts. He tracks sales and expenses in QuickBooks, which automatically processes the numbers.
“When you write everything down in QuickBooks, once a month you can print out a balance sheet,” Radosevich says. “I don’t even look at the balance sheet. I just send it to the bank once every quarter or so.”
A positive EBITDA is good, and the higher the better. With a higher EBITDA, you’re able to borrow more money at lower interest rates because you’re less of a risk. Conversely, a negative EBITDA means you’re losing money month to month. While you may be able to supplement with savings or income from another business to stay afloat, your business model is unsustainable over the long term. Your minimum EBITDA depends on how much money you need to borrow.
“Say an operator has round payments of $1,000 of principal and interest — EBITDA needs to be greater than $12,000,” Murphy says. “If the EBITDA is less than $12,000, then there isn’t adequate cash to make those payments.”
While these numbers can help you plan for financing, Radosevich says they’re not important for most day-
to-day operations. He sets money aside in a separate account for expenses like maintenance, and he keeps track of more basic metrics in the short term.
“I know every month on the 15th I have a payment of about $8,000 and I need to plan,” Radosevich says. “If you know your sales last week were $20,000, you know you’re going to get a bill from Roma for $5,000. I don’t need to see every day that my building has depreciated another $42.”
When it comes to financial planning, the best advice is to play to your strengths. Radosevich says that there are two ways to run a pizza business. Some operators focus on staying profitable and in the black, and simply make sure their pizza is good enough to keep customers happy. Others, like Radosevich, focus on quality pizza, and do just enough math to stay afloat. This approach can work, as long as you find someone to help with the more complex aspects of financing.
“Most of the time, people who go into small business need to have a rudimentary (financial) understanding,”
Radosevich says. “But the concepts you’re talking about are usually far beyond people who all they want to do is make pizzas. They should find an accountant who can explain these things.”
Robert Lillegard is based in Minnesota.
Knowing Your EBITDA
Finding your EBITDA is actually a fairly simple process if you keep good records. For each quarter, start by finding your operating income (or net revenue before taxes). If interest payments have been subtracted, add those back in. Also, add in depreciation and amortization expenses. Do this for each quarter and add the figures together to find your EBITDA for the year. When you do, exclude one-time expenses and any income/extra expense from operations that you no longer do (for example, if you used to cater but now you don’t). That will give you a realistic idea of your current EBITDA.
So what can you do to change your number? Well, you COULD hit your oven with a sledgehammer to speed depreciation. But realistically, the only way to get a better EBITDA is to add income and cut expenses.
“It’s not always easy to do, but it’s that simple,” says Brian Murphy of North Shore Bank of Commerce. “It’s a good thing to educate your operators about.”
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