It’s human nature to wonder how you stack up against competitors. Are you as profitable? How does your profit as a percent of sales revenues affect your company’s value?
Here’s how acquirers look at companies: Compare the key performance indicators (KPIs) that are “tells” of a well-run operation. Keep this central point in mind: Companies are acquired for their cash flow but valued on their EBITDA percentages.
The KPIs are Sales Revenue; Cost of Goods Sold (COGS); Gross Profit (GP dollars); Gross Profit Margin (GPM) by customer at least for the top 20 customers; Operating Expenses (OPEX); and EBITDA.
For this acquirer’s view, generate financial statements that express performance in dollar figures, but also what percent of the Sales Revenue those figures represent. When a potential acquirer is reviewing the financial statements, they will track percentage expression of KPIs on a quarterly and annual basis.
For Sales Revenue, they will look for growth percentage, quarter-over-quarter and year-over-year.
On the GPM line, they look for GPM percentages that improve over time, and they will examine the underlying reasons for any increase (or decrease) in GPMs.
On the OPEX line, they look at OPEX as a percentage of sales. As sales increase, OPEX as a percent of sales should decline, resulting in improved EBITDA.
Each of these KPI metrics play a critical role in the performance of the business.
Why the need to present percentages? When comparing your company to another, assume one does $20 million in sales with $5 million in EBITDA, and another $26 million, with $6.3 million in EBITDA.
Express the EBITDA as a percentage to make the comparison meaningful. The $20 million company reports that it made a 25% EBITDA margin (the formula is 5/20=25). The $26 million company can report that it made a 24.2% EBITDA margin (6.3/26=24.2). These two companies, different in revenue, perform at about the same EBITDA percentage.
Take an example where companies are far apart: If a $25 million company reports $1 million in EBTIDA, and the $30 million company reported $7 million EBITDA, the comparison is very telling.
The $25 million company (1/25=04) is operating at a very low 4% EBITDA margin, while the $30 million company’s EBITDA margin, with the $7 million in EBITDA, is cranking along at 23% EBITDA margin. Which one would you want to acquire? You wouldn’t base value on sales revenue. You’d base it on EBITDA performance as a percent of sales revenue.
Expressing percentages for other KPIs
Let’s take a closer look, assuming a hypothetical company with $32 million in sale revenue.
COGS and GP: Assume the $32 million revenue company has $23 million in cost of goods sold (COGS), yielding a $9 million gross profit. If you know the sales are $32 million, and the COGS are $23 million, then your $9 million GP represents 28.1% performance.
OPEX: Assuming $5 million in OPEX, your OPEX percent is calculated by dividing the OPEX by the sales revenues (5/32=) or 15.6%.
Operating Income: Subtract OPEX from the GP and you get operating income. Then convert it to a percentage. In our example, gross profit is $9 and OPEX is $5 million. So, the operating income is $4 million, or 12.5% of sales revenue. From there, EBITDA can be calculated.
EBITDA: EBITDA is the company income before it taxes, interest, depreciation, and amortization. The EBITDA will depend on the idiosyncrasies of your company’s taxes. In this example, it’ll be roughly $4.2 million. Since Sales Revenue is $32 million, and the EBITDA is $4.2 million, the EBITDA margin is 13.1%.
As important as the EBITDA is in dollars, the EBITDA percentage is the clearest expression of what portion of the Sales Revenue makes it to EBITDA, and it’s the gold standard for how well-run your company is, no matter its size.
John Wagner is a managing director at 1stWest Mergers & Acquisitions, which offers a specialty practice in the LBM sector. Reach John at j.wagner@1stwestma.com.
