There are many tools that business owners use to determine the financial success or profitability of their business, and one of them is called “EBITDA”. EBITDA is the acronym for “Earnings Before Interest, Taxes, Depreciation, and Amortization”. In some contexts it is used as an alternative to a company’s net income, but in general its purpose is to measure the overall financial success of a company. Simply put, it is a form of assessment for small businesses.
Lenders look at a business’s ability to be profitable over the long term, in addition to business debt, operating expenses, business performance, business income statement, and other elements indicating the company’s cash flow.
Read on to learn more about the importance of knowing your EBITDA when trying to secure a small business loan.
What do banks look for when deciding on a business loan?
Traditional banks often have the same metric when it comes to what they look for when making a business loan decision. This includes:
1. Credit Ratings
Credit scores between 640 and 700 are often considered good by business lenders. The minimum credit score required for SBA loans and term loans is around 680. Business owners at the lower end of this range will likely need extremely strong business references to qualify, such as several years of work. activity or significant annual sales showing an operating profit. If you don’t have either of these, you won’t be able to qualify.
Additionally, if your personal credit score is below 699 but above 640, you may want to explore other sources of lending to meet your business financing needs. For borrowers with credit ratings in this area, the best options for financing their equipment and medium-term loans will come from alternative lenders.
2. Financial statements
Financial statements and income statements are another factor banks use to determine if they want to give you a loan. Your company’s assets, liabilities and capital should be on the balance sheet, and the most recent balance sheet is the one that is considered most relevant as it identifies your company’s working capital. Ideally, your profit and loss statements should be at least three years old, although exceptions may be granted if you do not have a sufficient track record, but have strong credit and donable assets. warranty. You will also need to show as much profit and loss history as possible, going back up to three years. Your income statement will show your company’s total revenue.
In addition, you may also be asked to produce current and past loans and obligations taken on by your business, as well as the financial performance of all bank accounts, investments, credit cards and additional information such as tax identification numbers, addresses. , and coordinates.
If you’re a relatively new business, don’t worry. Banks can still offer you a loan, although they may ask for collateral. Therefore, for your business to qualify for a business loan, it must have tangible assets that can be used as collateral. When it comes to mitigating risk, financial institutions pay particular attention to the assets in question.
For example, if you intend to use your accounts receivable as collateral for a business loan, the bank will investigate major accounts receivable to determine whether the businesses holding these accounts are financially stable or not. In addition, the bank will only accept part of your claims as collateral for the loan, usually between 50 and 75% of the total. When you receive a loan on your inventory, the bank will only take a certain proportion of the inventory and go through many steps to ensure that it is not expired goods.
What is EBITDA and how is it calculated?
EBITDA is short for “Earnings Before Interest, Taxes, Depreciation, and Amortization” and is an operational term used to measure the financial health of a company. It can be used as a proxy for the total cash flow generated by the business.
There are two different approaches to calculating EBITDA on your own. To get started, all you need are your financial statements, especially the income statement and cash flow statement for the period you want to analyze. When it comes to monitoring performance, many companies choose to calculate EBITDA on a monthly or quarterly basis. Those expecting a sale may also be required to calculate it on an ad hoc basis to accommodate potential buyers.
Why and how lenders use EBITDA
Lenders can use EBITDA to review your company’s past financial performance and trends. To counter the effects of one-time or non-recurring capital expenditures, such as acquisition costs or the price of moving a facility, special adjustments are made. “EBITDA normalization” is the term used to describe this procedure.
When it comes to cash flow lending, lenders pay more attention to a company’s EBITDA than when it comes to asset based lenders. Cash loans are highly dependent on the company’s future financial performance to be repaid by its lenders.
What is the debt/EBITDA ratio?
The debt to EBITDA ratio shows how well your company can repay its debts. If the ratio is high, it could mean that a company is too leveraged. Banks will frequently specify a specific debt to EBITDA target. For a business to qualify for a loan, it must maintain the agreed level of debt, otherwise the entire loan could become due at once. Debt to EBITDA ratio is a common measure that credit rating agencies use to determine the likelihood that a company will default on issued debt. Companies that have a high debt to EBITDA ratio may not be able to service their debt properly, which can lead to a lower credit rating for the company.
Some EBITDA formulas used by many companies are:
1. EBITDA = Net Profit + Interest + Taxes + Depreciation + Amortization
2. EBITDA = Operating Profit + Depreciation + Depreciation
The result of both formulas will calculate the same number. Your EBITDA calculation can be done by yourself, by a professional or using calculation software. Be sure to also follow generally accepted accounting principles (GAAP) when compiling your financial statements.
GAAP is a compilation of authoritative standards established by the Financial Accounting Standards Board for the purpose of recording and presenting financial information. GAAP is designed to make the transmission of financial information more transparent, consistent and comparable.
Example of EBITDA
Here is a breakdown of how EBITDA looks based on the first formula method above:
|Provision for income taxes||$20,000|
|Net debit interest||$7,000|
|Depreciation and amortization||$9,000|
Measuring a business by EBITDA gives lenders better insight into your capital structures and operating income.
If you find that you need restructuring because you need to better understand how to establish business credit, or if you need financing options or loans for starting a small business, the place Nav Marketplace can help you quickly find what you need. Use our platform to instantly find your best business credit card and small business loan options based on your business data.
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