What is EBITDA? A Guide for UK Businesses

Written by James Dutton

What is EBITDA?

When a lender looks at a loan application, one of the first things they want to understand is how much cash the business is actually generating, before financing arrangements, tax position or accounting policy gets in the way. EBITDA is one of the main tools used to answer that question, and it comes up regularly in conversations around business loans, asset-based lending and business acquisition finance.

What does EBITDA stand for?

EBITDA stands for earnings before interest, tax, depreciation and amortisation. In practice, it's a way of measuring a business's underlying operating performance without the effect of how it's financed, how it's taxed, or how its assets are accounted for on paper.

Because it removes these variables, EBITDA makes it easier to compare businesses against one another, or to track a single business's performance over time, without those comparisons being skewed by a heavy debt load, a one-off tax position, or the depreciation schedule of a particular asset.

How is EBITDA calculated?

EBITDA is generally arrived at in one of two ways:

• Starting with operating profit and adding back depreciation and amortisation
• Starting with net profit and adding back interest, tax, depreciation and amortisation

Both routes should land on the same figure. What each element represents:

Earnings: typically, net profit, the revenue a business has generated once its costs have been deducted.

Interest: the cost of servicing existing borrowing, added back so the figure reflects performance independently of how the business happens to be financed.

Tax: added back because tax position can vary between periods and isn't a direct measure of how well the business is trading.

Depreciation: the reduction in value of physical assets, such as vehicles, machinery or equipment, over their useful life, added back as it's a non-cash accounting entry rather than money leaving the business.

Amortisation: the equivalent of depreciation for intangible assets, such as patents, licences or goodwill, also added back for the same reason.

Why do lenders use EBITDA?

Because EBITDA sets aside financing, tax and asset-accounting decisions, it gives a funder a clearer view of the cash a business's operations are capable of generating, and therefore how much of that cash could realistically be put towards repaying a facility.

What is the debt-to-EBITDA ratio?

The debt-to-EBITDA ratio compares a business's total debt against its EBITDA, being one of the more common measures a lender will apply when assessing an application or setting the terms of a facility. Broadly, it indicates how many years' worth of current earnings it would take to clear existing debt.

A lower ratio tends to suggest a business is carrying a manageable level of debt relative to what it earns, while a higher ratio can signal that debt levels are stretched. Some lenders build a maximum debt-to-EBITDA ratio into the terms of a facility, meaning the business needs to stay within that threshold for the duration of the agreement, or risk breaching the terms of the loan.

What can affect a business's EBITDA?

A number of factors can influence EBITDA from one period to the next, including:

• Revenue growth or decline
• Changes to the cost base, including staffing, materials or overheads
• One-off costs or income that fall outside normal trading
• Seasonal fluctuations in trading

Because of this, lenders will often look at EBITDA across several periods, rather than a single year in isolation, to get a fuller picture of how a business is performing.

Does a strong EBITDA guarantee finance approval?

Not on its own. EBITDA is a useful indicator of underlying performance, but lenders will typically weigh it alongside other factors, including cash flow, trading history, sector, and what any borrowing is being used for. A business with a strong EBITDA figure but inconsistent cash flow, for example, may still face more scrutiny than the headline number suggests.

Why does EBITDA matter when applying for finance?

Understanding your own EBITDA before approaching a lender can help set realistic expectations around how much a business might be able to borrow, and can also flag areas worth addressing before an application goes in. It's a figure that comes up particularly often in asset-based lending and business acquisition finance, where affordability is central to how a deal is structured.

Why use a finance broker?

Different lenders place different weight on EBITDA and apply different thresholds when assessing an application, and criteria can vary considerably depending on the sector and the type of facility involved. A broker with access to a wide panel of lenders can help identify funders whose approach is more likely to suit a particular business's financial profile, rather than a business needing to approach individual lenders to find out where it stands.

MAF Finance Group can compare offerings from a wide range of banks and alternative funders to help structure a finance solution around your business's circumstances.

To learn more or get a quote, fill out the form below. If you'd like to speak to someone directly, call us on 0115 858 1010 and a member of our team will be happy to help.