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Valuing Your Dealership: The Importance of EBITDAM and Earnings Quality

May 10, 2019

Many terms are used in the world of accounting that don’t make much sense anywhere else. One of these is the acronym EBITDA (earnings before interest, taxes, depreciation and amortization). Calculating EBITDA makes it easier to compare profitability between dealerships.

There’s another accounting acronym that’s important when valuing a business: EBITDAM, with the “M” referring to “management excesses.” Calculating EBITDAM can significantly impact your dealership’s value and potential selling price.

Normalize your earnings

All earnings are not the same from a valuation perspective, so a business valuation expert will attempt to “normalize” earnings by adding and subtracting different items. EBITDAM eliminates certain discretionary management expenses from the EBITDA equation to give a better picture of your dealership’s true profitability. These expenses often include:

• Rent that’s above (or below) fair market value,

• Owner salaries above (or below) what would be considered normal,

• Family members on the payroll who don’t provide services to the dealership, and

• Overremits in the F&I department going outside the dealership.

EBITDAM is calculated by adjusting EBITDA for such discretionary expenses. Here’s an example that shows the impact of calculating EBITDAM on valuation.

ABC Dealership has an EBITDA of $1.5 million. The business is valued at $7.5 million, using a multiple of five times earnings that was derived from sales of comparable dealerships. However, the owner is running $350,000 of discretionary expenses through the business, which includes paying himself and several family members above-market salaries.

The owner wants to have a business valuation performed, because he’s considering selling the dealership in the next year. Adding these discretionary expenses back to EBITDA would result in EBITDAM of $1.85 million. Assuming the same multiple of five times earnings, the dealership’s value would rise from $7.5 million to $9.25 million — an increase of $1.75 million, or more than 23%.

Determine earnings quality

Another adjustment to earnings to consider when performing a business valuation is one-time and nonoperational items. Examples include:

• Inventory valuation methods and used inventory negative equity,

• One-time items of income or expense, such as gains or losses on sales of assets,

• Unrecorded or underrecorded liabilities, and

• Debt and debt-like items, such as deferred compensation plans and pending legal disputes.

When making these kinds of adjustments, it’s crucial to understand the accounting methods being used in the dealership.

It’s also important to consider the quality of earnings. In other words, how much income is generated from a dealership’s core operating activities, such as selling and servicing vehicles and selling F&I products?

If your main sources of earnings are a strong sales team and strategic cost-cutting initiatives, you generally have high-quality earnings. However, if earnings come mainly from aggressive accounting practices, the sale of assets for gain or ever-changing economic factors, you generally have low-quality earnings.

High-quality earnings are readily repeatable. They aren’t caused by temporary, unsustainable events or external factors, such as low interest rates or strong economic growth.

It’s important to be aware of the relative strength of your dealership’s earnings. One way to shed light on earnings quality is to have a “quality of earnings” study performed by an accounting professional. This study will make appropriate earnings adjustments to give buyers and sellers greater assurance that the stated earnings are viable and sustainable in the future.

What’s your true profitability?

Before putting your dealership on the market, it’s important to consult a business valuation professional to understand how to normalize and assess the quality of your earnings. These steps will help reveal your dealership’s true profitability, which will result in a more accurate valuation and possibly a higher selling price.

© 2019