EBIDTA is an accounting term that stands for Earnings Before Interest, Tax, Depreciation, and Amortization. The first three elements—earnings, interest, and tax—are relatively straightforward. Earnings are the money you bring in, or your revenue. Interest could be the interest on a mortgage payment or other debt. And we’re all pretty familiar with taxes.
Depreciation and amortization are a little more complex. They’re paper losses that show up at the end of the year. Depreciation applies to assets that lose value over time, and amortization is for assets where you spread the payments out over a period of time.
In real estate investing, it’s important to have separate categories for these different expenses. You have your total income, but then you also have all of your expenses, including those that apply to EBITDA and those that don’t. All together, that creates your net income for tax liability.
So why is EBITDA important for your banker?
EBITDA is what bankers use to return profitability to your business. If your books aren’t structured in a way where things are properly applied to EBITDA, it can create some challenges when meeting with your banker. You could be looking at financial statements and trying to make on-the-fly adjustments in the margins rather than having a substantial conversation with your banker about your next steps.
Ultimately, you want to style your books to make sure your financial statements communicate everything and clearly calculate EBITDA. Another important thing is to model your books as they’ll be applied to your tax return. Your tax return has all the standard business expense categories, then it also has interest, taxes, depreciation, and amortization. If your books are structured the right way, it’s really easy for both your banker and your tax preparer to look at your books and know the whole story.
With the right approach to your bookkeeping, you’re now prepared to fully engage in the conversation about next steps in your investment strategy. Having a basic understanding of EBITDA instantly upgrades your credibility with the bank, and it helps them make a quicker assessment on whether to loan you money.
When a banker can look at the page and quickly find the information they need, you can more quickly engage in a conversation about the why and the how.