Any business owner who tracks their books knows how valuable EBITDA (earnings before interest, taxes, depreciation, and amortization) can be. EBITDA measures core (or operating) business profitability, before debt, taxes, or asset maintenance come into play. Even though EBITDA is not part of GAAP, it’s almost universally included in income statements because it helps external parties better understand how a business is performing. Knowing EBITDA answers a critical question — is this a fundamentally good business?
If EBITDA is negative, for example, it tells you that the business has serious operating issues. It might be spending too much on marketing to attract new customers, having too few customers to cover fixed costs, or even not charging enough to offset variable costs for each customer.
That said, positive EBITDA doesn’t mean a business is profitable, especially if it spends a lot on CapEx to operate.
Still, EBITDA is routinely used in the business community to compare company valuations, usually expressed as a multiple. A growing technology company might sell for anywhere from 3 to 10x EBITDA. Large companies with a significant moat (e.g. proprietary technology) might expect even higher multiples of between 10 and 15x or more.
While EBITDA tries to get to the core performance of a business by subtracting non-operating expenses, there still might be some non-recurring expenses that muddle the picture. Subtracting those can help clarify business performance even further — in a metric called adjusted EBITDA.
Adjusted EBITDA drills down further to analyze the core operating business by adding back additional one-off expenses or subtracting non-operating income – COVID-related loans for example. The expenses can vary widely and include debt write-offs, employee bonuses, legal expenses, COVID-related spending, etc.
Unlike EBITDA, adjusted EBITDA varies for every company. Knowing how to calculate it properly (and reasonably) for your business can be the difference between being valued at a lower or higher multiple in an acquisition or investor negotiations.
That’s why adjusted EBITDA is crucial for IT service providers that are looking to sell their business or bring in external investors. Getting the adjusted EBITDA right can increase the company’s valuation by a whole multiple (or more) — meaning hundreds of thousands or more added to the purchase price.
Although adjusted EBITDA is different for each company, there are still common adjustments that tend to be used by most IT service providers.
Note: EBITDA adjustments can both increase and decrease the value of your company. While they are more likely to do the former, it’s important to be clear truthful, and reasonable, so others can see how your business really works.
Here are just a few typical EBITDA adjustments you’ll see ISPs make.
Additionally, the COVID-19 pandemic has added lots of one-time expenses that could obscure the true health of the business:
As mentioned above, while adjusted EBITDA is not a strict accounting metric, it helps outsiders (e.g. financial analysts) evaluate the core of the business without unusual gains or expenses. Adjusted EBITDA growth over a few years, for example, shows that the core business is in a good place and makes forecasting easier.
In turn, this gives potential acquirers a solid base from which they can calculate the company’s valuation based on growth and future returns, without being distracted by extraordinary events, such as the COVID-19 pandemic.
Since EBITDA and adjusted EBITDA are common industry metrics, they are often used for benchmarking and comparing different IT firms. If one company’s adjusted EBITDA margin is 40% and another one’s is 30%, we know that the former is more efficient and can take a closer look at its financials.
It’s easy to be swayed by one-off gains and happily book large increases in profitability. But why rely on lottery tickets and external events?
Adjusted EBITDA helps keep the business grounded, growing its core operations, which results in more realistic and resilient measurements over the long term.
Not sure where to start with adjusted EBITDA? Contact the Host Broker, and we’ll guide you through the process — and even give your business a free evaluation.
Know more about your business and how it performs compared to your industry peers by connecting with us today!
If you’re in the market to buy or sell a web hosting business, it’s important to understand the concept of ‘deferred revenue’ and how it impacts your valuation. Deferred revenue is a liability reflecting money that’s already been collected for services that are to be rendered in the future. Whereas normally revenue contributes positively to a hosting business’ valuation, deferred revenue decreases the valuation by virtue of being a liability. Hosting company valuations are largely determined based on the recurring revenue (i.e. the Annual Recurring Revenue, or ARR). As a general rule of thumb, a typical valuation of hosting businesses floats around 1x ARR, although it does vary. But revenue that’s already received for work to be done for periods in the future is considered deferred and is subtracted from the valuation. In practice however, most buyers define deferred revenue for the purposes of adjustments to an offer as revenue that is received for periods that exceed 1 year in the future. Let’s say you sell a hosting plan with a two year billing cycle; basically the first year contributes to the ARR calculation and increases the valuation, and the second year is deferred revenue and needs to be subtracted from the valuation.
Today’s blog goes through the steps to calculate deferred revenue.
First you must export an order history report from your billing system, where each and every order is given as a row along with a billing cycle duration column. There will be a mixture of billing cycles including monthly, annual, semi-annually, and more. We instead want an apples-to-apples comparison and do so by calculating the daily revenue.
Now you should have something that looks like the PivotTable below, listing all of the billing cycles being utilized.
The next step is to determine a multiplier for each billing cycle that turns it into daily revenue.
Now we’re going to use a vlookup formula to match the appropriate multiplier with the appropriate billing cycle for each row. We’re going to do this by creating a formula in the new ‘Daily Revenue’ column. An example formula is as follows:
=I2*VLOOKUP(J2,’Daily Revenue Multiplier’!A:B,2,FALSE)
Once the formula is created, drag it all the way down, so that daily revenue is calculated for every row in the order history sheet.
If this part has been confusing, I’d highly suggest doing some reading on how vlookup formulas work. A misstep here will throw off all of our calculations because everything is based on having an accurate daily revenue calculation.
Now that we know the daily revenue amounts, we need to determine how many days of deferred revenue there are for each order. To do so, we calculate the number of days remaining for each order beyond a year from today (assuming the data was exported today).
Excel expresses unformatted dates as a five digit number. Using these, we subtract a-year-from-now from the last date of the billing cycle. Let’s assume that the last day of an order’s billing cycle is Dec. 31, 2022 and a-year-from-now is Jan. 6, 2021. The five digit code for the former is 44926 and the latter is 44202. The difference, 724, is the number of days of deferred revenue. We now need to perform this same calculation on every order using a formula.
Now that we’ve calculated the daily revenue for each row, and the number of days where deferred revenue applies, we can multiply the two together to calculate ‘Deferred Revenue’. Simply create a new column entitled ‘Deferred Revenue’, use a formula like =P2*Q2 to do the calculation, and drag it all the way down.
There are a number of ways to determine the total ‘Deferred Revenue’. You can simply highlight the entire column and note the total. Or you can use a formula like =SUM(R:R). Or you can highlight the entire order history table, click the ‘Insert’ ribbon, create a PivotTable, and drag ‘Deferred Revenue’ under row labels. And we’re done!
I hope you found this article about how to calculate Deferred Revenue for a web hosting company helpful. If you have any questions, please reach out to us at [email protected]. If you are interested in selling your business please click here for a free evaluation Free Evaluation
You may also enjoy reading: Maximize Future Value: Key Components to Consider When Building Your IT Services Business