EBITDA for Business Loans: Formula, Example and Limits

What EBITDA measures

EBITDA shows operating profit before financing costs, tax and non-cash charges, so it is a view of earning power independent of how the company is financed.

Net income includes items that depend on choices unrelated to day-to-day operations: how much debt you carry, what depreciation method you use, which entity type you picked. EBITDA strips them out to leave the profit from running the business itself.

That makes it handy for comparing companies, and for asking a lender's favorite question: how much cash does the operation make before debt payments? It is not a replacement for cash flow. It does not subtract capital spending, changes in working capital or the debt payments themselves.

How to calculate it

Start with net income and add back interest, taxes, depreciation and amortization. Or start with operating income and add back depreciation and amortization.

Both routes land on the same number when the statements are clean.

You will find the inputs on your income statement. If you are unfamiliar with it, start with the income statement basics. Many small businesses file as pass-throughs, which means owner pay may not appear as an expense. Funders sometimes adjust for that, so expect questions about owner compensation.

How lenders use it

Lenders use EBITDA to test whether operating earnings can cover debt payments and to cap total debt as a multiple of earnings.

Two uses come up most often.

• Coverage: compare EBITDA, or a cash flow figure derived from it, with annual debt payments. A business earning $160,000 with $100,000 in yearly payments has a coverage of 1.6.
• Leverage: total debt divided by EBITDA. Some agreements set a maximum multiple. See covenants in business loans.

The role of EBITDA grows with deal size. SBA loans and larger bank term loans rely on tax returns and financial statements. Smaller working capital, revenue-based and line-of-credit decisions rely mostly on deposits and bank statements, since many small owners keep books on a cash basis that makes EBITDA hard to compare.

The limits of EBITDA

EBITDA ignores capital spending, working capital needs, tax payments and the debt itself, so it can overstate how much cash is truly available.

A trucking company with $160,000 in EBITDA may need to replace vehicles every few years. A retailer may need to buy more inventory every season. Neither cost shows up in EBITDA, yet both consume cash.

Many credit professionals look at EBITDA minus capital expenditures, or at free cash flow after owner pay, for a more cautious view. Owners should do the same. If you size a loan on EBITDA alone, you may commit more than the business can safely repay. Compare it with the cash flow versus profit picture of your own books.

Adjustments and add-backs

Lenders may adjust EBITDA for one-time costs and owner perks, but each add-back needs documentation to count.

Common add-backs include a one-time legal settlement, moving costs, or personal expenses run through the business. They are legitimate when real and documented. They invite skepticism when they are large, repeated every year or hard to verify.

Keep a short schedule of adjustments with supporting records. A reviewer who can trace each item to an invoice or statement is more likely to accept it. Never inflate EBITDA. Statements signed on an application carry legal weight, and inaccurate figures can cause far worse problems than a smaller loan.

A simple EBITDA-to-payment check

You can test your own capacity in a minute with two numbers.

Take annual EBITDA and subtract a realistic amount for owner pay and for equipment you must replace each year. Divide what remains by the yearly payments on all debt, including the new loan. If the result is comfortably above 1, the business generates more than it owes in payments. If it is near 1, a single weak quarter could cause trouble.

For example (illustrative), EBITDA of $160,000, owner pay of $60,000 and replacement spending of $15,000 leave $85,000. Against $60,000 of yearly payments, that is a coverage of about 1.4. This is only a quick screen, but it is closer to what a careful funder will do than the raw EBITDA figure.

When EBITDA matters for your funding choice

Expect to supply it for SBA and large term loans. For working capital and lines of credit, recent bank statements usually carry more weight.

If you are seeking a large term loan or an SBA loan, have two to three years of statements and tax returns ready and know your EBITDA. If you need speed or a smaller amount, a complete file at ROI Funder is the application plus three months of business bank statements, and funds can arrive the same business day on approved, complete files.

ROI Funder considers 500+ FICO, 6+ months in business and $20,000+ in monthly revenue. Either way, compare offers using true cost, not just earnings ratios.