You’ve probably heard the term ‘EBITDA’ tossed around in conversations about buying or selling landscape companies. If you’re not planning on selling, you may wave EBITDA off as something you don’t need to worry about. However, it is a useful tool for running your business, regardless of your plans for the future.
What Is EBITDA
EBITDA stands for Earnings Before Interest, Taxes, Depreciation and Amortization.
For example, if a landscape company has $1 million in net profit, and during the year it had:
- $80,000 of interest expense
- $120,000 of income tax expense
- $180,000 of depreciation
- $20,000 of amortization
When those four amounts are added back, the EBITDA is $1.4 million. Thankfully, the four pieces are easier than the name makes them sound.
Interest
This is the cost of borrowed money. Imagine two landscape companies with identical operations. If one owner borrowed $1 million at 8% to pay for equipment and acquisitions, that company has $80,000 a year in interest expense. If the other owner used his own money, he has no interest expense.
“The first company’s bottom line will be lower because of that financing decision,” says John Joestgen, principal of JJ Landscape Consulting. “But did its crews suddenly get less productive? Was there more overtime? Did it estimate jobs worse? No. By adding back the $80,000 of interest, EBITDA lets us compare the operations without the owner’s financing decision clouding the comparison.”
Taxes
For EBITDA, Joestgen says these are mainly income taxes. How the company is owned and set up can also change how much tax shows up on a P&L.
“Should the business be judged on how the owner set up the company for taxes, or on whether they’re using losses from prior years to lower this year’s taxes?” Joestgen says. “I set taxes aside.”
Depreciation
This is how the cost of trucks, mowers and other equipment is spread over a set number of years for accounting purposes. It can differ greatly from how long the equipment actually lasts.
“Depreciation matters a lot in landscaping because we use so much equipment,” Joestgen says. “Two similar companies can show very different depreciation because of the age of their fleets, how they decide what gets depreciated and which depreciation method their accountant uses. EBITDA adds depreciation back so we can look past that accounting charge.”
Joestgen cautions that adding depreciation does not make the truck free.
“EBITDA doesn’t tell you how much money is in the bank any more than net profit does,” he says.
Amortization
Meanwhile, amortization is the gradual spread of expenses for intangible assets like software or startup costs.
“Should the business be judged on software costs from years ago, or startup costs that are still being written off?” Joestgen says. “I set amortization aside.”
Why Track EBITDA If You’re Not Planning to Sell
Joestgen notes EBITDA shouldn’t replace net profit. It simply gives management another way to look at the same business.
“EBITDA asks a different question: How well is the business itself performing before interest, taxes, depreciation and amortization?” he says. “Those four items depend a lot on how the company is financed, how it’s set up for taxes and how the accountant handles them. They have very little to do with how well you sell, estimate, schedule and produce the work.”
Joestgen says that EBITDA helps owners determine the company’s ability to operate and make a profit. Basically, it takes four elements that have nothing to do with how well the machine runs and doesn’t hold it against the company.
“Now you have a clearer picture of what the business is doing day to day, week to week and month to month, without those four items clouding things,” Joestgen says. “That’s what bankers and investors want to understand.”
By looking at both numbers, it can expose a problem that net profit hides.
For example, if your operations performed $100,000 worse this year but at the same time you paid debt down last year, your interest expense dropped by $100,000 as well. The two changes cancel each other out, so your net profit looks the same as last year.
“Management looks at the bottom line and says, ‘We’re fine,’” Joestgen says. “But you’re not fine. EBITDA takes the interest savings out of the picture and shows that the operation actually got $100,000 worse.”
Similarly, depreciation can also hide signs your operations have declined if several older trucks and pieces of equipment are now fully depreciated, so depreciation expense also drops by about $100,000.
“That’s one of the reasons I like having both numbers,” Joestgen says. “But EBITDA still doesn’t diagnose the disease. It only tells you where to start looking.”
As for whether an EBITDA is ‘healthy,’ there is no one set number as it will vary based on company size and service mix.
Joestgen recommends comparing your results in three different ways:
- First, refer to your own budget and your own history.
- Second, refer to companies that are truly similar in size and service mix.
- Third, break your company into meaningful profit centers and compare their results over time.
Ways to Improve Your EBITDA
After your management team has identified an issue by comparing EBITDA to your other numbers, you need to drill down from the company as a whole to the branch, then specific profit centers and finally supervisors or foremen.
“The number is valuable when it points management to the right question, and when there’s a system in place to hold the right people and departments accountable,” Joestgen says.
If you want a higher EBITDA, Joestgen says it comes down to improving the business. He discourages attempting clever accounting tricks like not selling trucks, putting off maintenance or waiting to start a new service line.
“That may make the number look better for a while, but it doesn’t necessarily make the business better,” Joestgen says. “Today’s buyers are much more experienced. If you’ve just pushed tomorrow’s expenses off today’s P&L, expect some uncomfortable questions during due diligence.”
A good rule of thumb when making business decisions to improve EBITDA is to ask, ‘If you knew you were never going to sell the company, would you still make this decision?’
“If the answer is yes, you’re probably building real value,” Joestgen says. “Better productivity, less rework, better pricing, better routing and purchasing, and keeping good employees and customers all pass that test.”
