You’ve probably heard you should know your restaurant’s EBITDA.
But what is EBITDA? What is it good for? And … how do you pronounce it?
In this article, we’ll go through everything you need to know about EBITDA. No, you won’t leave this article an accountant. But you will know:
What EBITDA is
What EBITDA is not
How EBITDA is used
Problems with EBITDA
How to calculate EBITDA
How to improve your EBITDA
First: How Do You Pronounce “EBITDA”?
EE as in “see”.
BIT as in “rabbit”.
DAH as in “Delilah”.
Now that this is out of the way, let’s get into it.
What is EBITDA?
EBITDA is an acronym for “earnings before interest, taxes, depreciation, and amortization”.
While its use remains controversial as a true indicator of profitability, EBITDA is used by restaurants to determine their worth before the effects of interest payments, asset depreciation, tax implications, etc.
EBITDA is widely used as a proxy for cash flow. EBITDA represents earnings that are a result of operations only, while stripping away the effects of financing, accounting, and capital spending on your restaurant’s earnings.
Why? Because your financing, accounting, and capital expenses are not the result of your actual business operations – they are also influenced by capital structure, tax jurisdiction, and interest payments. For example, earnings reported under EBITDA wouldn’t be affected by the monthly interest on leased kitchen equipment.
Restaurateurs and investors use EBITDA as a part of their decision making when they’re looking to sell, buy, or invest in a restaurant, as EBITDA is used for a restaurant’s valuation. Two restaurants may very well have similar similar EBITDAs, but very different operating profits.
What Is EBITDA … Not?
So now that you know what EBITDA is, here’s what it’s not.
EBITDA is not meant to measure your actual profitability. EBITDA is a proxy for cashflow. In other words, it’s how much your restaurant earns from its operations.
EBITDA is not operating profit or EBIT. It’s easy to confuse EBITDA with other key performance indicators, namely operating profit and EBIT (which are synonymous).
Here’s the difference:
Operating profit is the actual profit you make from your core operations – what remains after the cost of doing business.
Operating, or EBIT, profit includes depreciation and amortization. But unlike EBITDA, EBIT doesn’t account for interest and taxes. EBITDA, on the other hand, is focused on cash. And operating profit is what you’ll report on your profit and loss statement.
Why Is EBITDA Useful for Restaurants?
Here are five main use cases for EBITDA:
To compare a restaurant against competitors
To determine whether to buy, sell, or invest in a restaurant
To prove your restaurant’s operational performance when trying to acquire financing
To sell potential investors on your restaurant
To perform a health check on your restaurant’s earnings from operations
EBITDA is an effective way to level the playing field for comparison between restaurants, who may have differing capital spending set, financing, and regional tax structures.
For example, one restaurant may lease their kitchen equipment while another may have purchased it. EBITDA allows stakeholders to compare the earnings of two restaurants without the effects of those purchasing decisions.
You’ll see EBITDA reported in the profit and loss statements of public restaurant companies, typically franchises.
It’s important to note that, unlike operating profit, EBITDA isn’t a mandatory disclosure under the U.S.’s Generally Accepted Accounting Principles (US GAAP), which govern the disclosure requirements of public companies. But many restaurants include EBITDA in their reports regardless.
The Problem(s) with EBITDA for Restaurants
So it’s no secret: EBITDA is a controversial measurement of success. The main reason is because EBITDA may make your business look healthier than it actually is. Here’s how.
EBITDA can be inconsistent. There are a few ways to calculate EBITDA (which we get to later). Each calculation has the potential to produce a different result, and varying results can cause inconsistencies when comparing EBITDAs between businesses or when viewing a single business’ EBITDA over time.
EBITDA can be malleable. It’s easy to fluff EBITDA so that a restaurant looks more profitable than it is. Some businesses have been found to use one calculation one year and another the next, so that it looks like they’ve experienced greater growth than they actually have.
EBITDA isn’t regulated. Since EBITDA isn’t regulated by American accounting standards, US GAAP, public restaurant groups are at liberty to disclose the figure without scrutiny.
EBITDA shouldn’t stand alone. While some restaurateurs and investors consider EBITDA the measure of operating performance, remember that the restaurant business is a fairly capital intensive, asset-heavy industry. Purchased restaurant equipment depreciates quickly, and leases can carry large interest payments.
How To Calculate EBITDA
First, a note: we know you’re probably not an accountant.
If you’re not, make sure you have a great accountant to help you.
In other words, don’t try EBITDA at home.
Leave the hard calculations to your accountant or bookkeeper. But, for your general knowledge, EBITDA can be calculated in a few ways, and you’ll want to know so you know what your accountant is doing.
1. EBITDA formula based on operating profit
EBITDA = Operating Profit + Amortization Expense + Depreciation Expense
This formula is the simplest way to calculate EBITDA because operating profit is reported on income statements. The calculation uses operating income as the source of earnings, since the exclusion of amortization and depreciation is the only real difference between the figures. Note that you may need to add interest here if interest is part of your operating profit.
2. EBITDA formula based on net income
EBITDA = Net Income + Interest + Taxes + Depreciation + Amortization
Net income is your revenue minus expenses for any given period. Also interest and taxes are added to this equation, along with amortization and depreciation. This includes additional income from investments, secondary operations, and one-time payments for asset sales.
3. EBITDA margin formula
EBITDA Margin = EBITDA / Total Revenue
EBITDA margin is used to express EBITDA versus your revenue.
The Ideal EBITDA Margin
So we will warn you: there is a lot of conflicting information out there on the ideal EBITDA margin.
According to Aaron Allen and Associates, “Publicly traded restaurants in the US have a median EBITDA margin of 13%.... Two thirds of the companies in the top quartile (those with margins higher than 18.7%) are QSR concepts.”
But then, according to research by NYU, restaurants should aim for an industry benchmark EBITDA margin of 20.52% compared to a total industry average of 15.02%.
And even more still according to the Financial Times, “Businesses in the services sector, which covers everything from waste management to restaurants to law firms to software companies, have average EBITDA margins of 30.6%.”
Note that you should calculate and review your EBITDA any time you create a profit and loss statement.
How to Improve Your EBITDA
To improve EBITDA, you must reduce your costs or increase your earnings. Here are some ways to achieve this.
Upselling: Tell your servers to upsell menu items with high profit margins. Here are four ways to make upselling look like great customer service.
Menu engineering: Menu engineering is the concept of designing your menu for profits. One part art, one part science, menu engineering employs visual design concepts, strategic placement, and human psychology to guide diners towards menu items with the best profit margins. Read more about menu engineering here.
Monitor labor costs: You may be able to knock off some low-hanging fruit by reviewing your labor reports and analytics. Restaurateurs who don’t use data to make scheduling decisions are missing out on some efficiencies that could save them significant costs. Check your labor reports regularly against seasons, holidays, times of days, etc. to make sure you schedule the exact amount of staff when you need them – and not when you don’t.
Improve inventory management: Poor inventory management effects EBITDA. Spoiled ingredients, excess ordering, improper portioning, and rising supplier costs cause you to spend money than you need to. Learn more about inventory management here.
FYI: Discounts won’t improve EBITDA. Be warned that discounting your prices may be a quick way to fill seats, but it actually reduces EBITDA. Why? Because you’re still paying the same food cost, but you’re reducing your margin.
EBITDA: it’s one of those financial metrics that can be a bit hard to wrap your head around. But if you’re a restaurant owner, you’ll want to ensure your operations are set up to generate earnings despite your financing decisions. And if you’re looking to buy or invest in a restaurant, you want to make sure that restaurant is set up for success.
About the AuthorMore Content by Bruce Macklin