As a startup founder, you’re likely juggling a whirlwind of priorities – growth, product development, customer acquisition, and, of course, managing your finances. Amid all the financial metrics and KPIs vying for your attention, one stands out as a critical measure of your startup’s performance and profitability: EBITDA.

But what exactly is EBITDA, and why should you care? In this blog, we’ll break down this essential financial metric, explain why investors and founders alike rely on it, and show you how to use it to better understand your business’s health.

What Is EBITDA?

EBITDA stands for Earnings Before Interest, Taxes, Depreciation, and Amortisation. At its core, EBITDA measures a company’s profitability by focusing on its core operations, stripping out expenses related to financing, taxes, and non-cash accounting items.

Think of it as a clean, streamlined view of your startup’s ability to generate profits from its day-to-day activities – without being clouded by external factors like loan repayments or tax strategies.

Why Strip Away These Costs?

• Interest: Financing decisions (like taking on debt) can vary widely between startups and don’t reflect operational performance.
• Taxes: Tax liabilities depend on factors like geography and corporate structure, which aren’t directly tied to operational success.
• Depreciation & Amortisation: These are non-cash accounting charges that relate to historical investments in assets. They’re important but don’t reflect the current profitability of your operations.

Why Is EBITDA Important for Startups?

EBITDA is often referred to as the “operating cash flow proxy.” For startups, this metric offers several key benefits that make it invaluable when managing growth and attracting investors.

A Pure Measure of Operational Performance

EBITDA focuses on your core operations, cutting out the noise of financing and tax strategies. It answers the question: “Is this business fundamentally profitable?”

Attracting Investors

Investors love EBITDA because it’s a standardised measure that makes comparing startups easier. A strong EBITDA shows your startup can generate profits efficiently, which can justify higher valuations.

Cash Flow Insights

While it’s not the same as cash flow, EBITDA often acts as a proxy. A positive EBITDA indicates you’re generating enough to cover operating costs, even if you’re reinvesting heavily in growth.

Preparing for Exit

If you’re eyeing an acquisition or other exit, EBITDA will likely be a major focus during valuation discussions. Buyers use it to assess your business’s earning potential and compare it to competitors.

How to Calculate EBITDA

Calculating EBITDA is straightforward if you already have your profit and loss (P&L) statement. Here’s the formula:

EBITDA = Operating Profit + Depreciation + Amortisation

Alternatively, if your P&L doesn’t show operating profit, you can calculate EBITDA like this:

EBITDA = Net Income + Interest + Taxes + Depreciation + Amortisation

Example:

Let’s say your startup’s financials for the year look like this:

• Net Income: £100,000
• Interest Expenses: £20,000
• Taxes: £10,000
• Depreciation: £15,000
• Amortisation: £5,000

EBITDA = £100,000 + £20,000 + £10,000 + £15,000 + £5,000 = £150,000

Your EBITDA is £150,000, giving investors a clear view of your profitability from operations.

What Are the Limitations of EBITDA?

While EBITDA is a valuable metric, it’s not perfect. Here are a few limitations to keep in mind:

It’s Not Cash Flow

EBITDA excludes key cash expenses like loan repayments and capital expenditures, so it doesn’t fully reflect your liquidity or ability to meet short-term obligations.

Ignores Debt and Tax Strategies

For heavily financed startups or those operating in high-tax jurisdictions, EBITDA may paint an overly optimistic picture of profitability.

Doesn’t Include Asset Costs

Depreciation and amortisation reflect the wear and tear or intangible value of your assets. Ignoring these costs might make your business look more profitable than it truly is.

How to Improve Your EBITDA

A strong EBITDA can boost your valuation and attract investors, so optimising this metric should be a priority. Here’s how:

Boost Revenue Without Increasing Costs

Focus on increasing sales while keeping fixed costs stable. Upselling to existing customers or launching high-margin products can drive revenue growth without significantly raising expenses.

Cut Unnecessary Operating Costs

Review your expenses and identify areas where you can streamline. This could mean renegotiating supplier contracts, automating processes, or outsourcing non-core functions.

Focus on High-Margin Products

Shift resources to the products or services with the highest margins. This will improve overall profitability and enhance your EBITDA.

Wrapping It Up

EBITDA is a powerful metric that every startup founder should understand. By providing a clear view of your operational profitability, it helps you manage growth, attract investors, and prepare for future exits. While it’s not the only financial metric you should track, it’s a key indicator of your startup’s health and potential.