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Financial jargon coupled with astronomical numbers. All splattered across a piece of paper or computer screen. What is this?! Your anxiety surges out of control. It’s just an income statement – profit and loss statement, or P&L for short. If we could just, maybe, alter this financial statement a tad. Just to condense it, to make it just a little more understandable. Image is everything – and all financial information can be grasped with the right financial presentation.

Our journey to do that begins with the discovery of EBITDA – and no, you don’t have to be a Wall Street exec or a high-speed, info-devouring financial analyst to comprehend it. You – yes, you – can understand and use this key financial metric for your tree care company. A simple number, yet a financial, operational eye-opener. You can have many key performance indicators – and having a variety can tell you many different things about your company. This is a key one.

Defining EBITDA
To understand EBITDA, let’s break down this acronym into delicate parts, just like a chain saw you are interested in fine-tuning and rebuilding. When you understand the inner workings of a machine, you can gain a deeper level of understanding and respect for it.

Here we go:
Earnings Before Interest Taxes Depreciation and Amortization

That’s it. But to really understand the core components of this metric, let’s dive into just a few definitions for even more clarity. This will really help us understand each word and learn how to easily grasp EBITDA:

• Earnings: Just another word for total sales, revenue or income. Or simply referred to as the “top-line.”
• Interest: The cost associated with the use of debt and/or financing.
• Taxes: Involves income-tax payments that correlate to the net profit/taxable income.
• Depreciation: The expensing of a fixed asset. The value of the asset is held on the balance sheet, then expensed over time on the income statement.
• Amortization: Just like depreciation, amortization is the routine expensing or cost recovery of intangible assets. This includes items that also are known as assets and are included on the balance sheet. Think of patents, trademarks and copyrights.

Is the fog fading away? Is everything coming together? Let’s move along – wait! Let’s quickly clear up two financial
conceptions that can throw non-
accountants or non-financial-statement people into quite a frenzy.

Figure 1: Computing the value of EBITDA. Graphic courtesy of the author.

Digging deeper
Depreciation and amortization. Now, don’t let these concepts scare you. They are fundamentally simple to understand.

First and foremost, depreciation, along with its extremely close counterpart, amortization, is what we classify as non-cash expenses. Is it making sense to you? So, they are expenses that do not require a reduction in cash. Hang in there.

Let’s break this down even further. Depreciation and amortization are basically accounting entries that allow us to expense, or reduce the value of, fixed assets purchased. You never write a check to Depreciation Inc. or Amortization and Co. to satisfy these payments. Fixed assets are expensed in increments over the useful life, which is usually represented in years.

The value of EBITDA
There are two ways to discover the value of EBITDA. Choose whichever one makes sense to you, or that you find is easier to compute. See the accompanying chart (Figure 1) to follow along with the numbers:

• Take your total sales, then subtract your operating expenses. This is the most straight-forward approach that begins at the top and moves down. Starting with sales of $5 million, just deduct total operating costs of $3 million to compute an EBITDA of $2 million.
• This next approach starts at the bottom and reaches up. Take your net income of $450,000, then add the following items back into that number: tax expenses of $300,000, plus interest charges of $250,000, plus depreciation/amortization (grouped together as one lumped item) at $1 million, which stills gets us to an EBITDA of $2 million.
• In short, we are on a quest to find what we earned after operational expenses, or what we earned before having to make any payments of interest and taxes, and before incurring or recording any depreciation and/or amortization expenses.

Starting at the top, like the canopy of a tree, we have Sales, which equate to $5 million. From there, total operating costs of $3 million are deducted to get us our main item of discussion – EBITDA of $2 million. Think about the acronym. From there we will systematically deduct each of the following items: interest, taxes, depreciation and amortization. Before we continue, do you notice how this method creates a nice, easy-to-follow format?

Figure 2: Adding perspective. Graphic courtesy of the author.

From there, depreciation/amortization of $1 million is deducted, which brings us to Earnings Before Interest and Taxes of $1 million. Now, let’s subtract our interest charges, which total $250,000, and bring our Earnings Before Tax (EBT) to $750,000. Assuming we have a 40% tax rate, or a tax expense of $300,000, our bottom-line, net profit, net operating profit, net income – whew, words – is $450,000.

Again, the presentation style of this income statement flows smoothly, eventually bringing you toward your net profit. What are some advantages to this format? Well, while it doesn’t give us intricate account details, we do walk away knowing our major account totals.

Putting it to work
Also, this format can serve as a simple-to-understand template that can be used in multi-year, company or industry comparisons. For instance, if you are interested in how your tree care company is performing within the industry or among peers, you can quickly assess EBITDA, along with sales and net-profit figures to get a glimpse into your operation’s performance. You also can build metrics and analyze percentages to bring a tighter focus to your numbers – and make the amounts more relative.

For instance, in this example, our EBITDA is 40% of total sales; to get this figure, simply divide EBITDA by total sales, or $2 million/$5 million. This now can be compared to industry metrics and figures to again see where your company stands.

Which way are you going?
How was your company performance last month? Last year from the date of your financial report? Keep in mind, where something is going – its direction – can be more important than where it is.

Notice how in Figure 2 we have an EBITDA of $5 million. The previous month totaled $5.5 million. When we compare the two, it appears we performed badly. But let’s look at the previous year, assuming 12 months ago, and we find that our EBITDA total was $4 million. Charting our business journey with EBITDA, we went from $4 million up to $5.5 million, and down to $5 million. From start to finish, we still grew – our business performance is still favorable.

Bottom line
Even though EBITDA is a non-GAAP (Generally Accepted Accounting Principles) metric, it can still be a helpful tool in assessing operational performance and seeing where your company measures up against counterparts in the industry. Like going “low and slow” when learning new tree care and climbing techniques, an income statement that exhibits an EBITDA-focused layout is, again, not as intimidating to look at. And it is a good starter/financial-analysis tool for someone new to financial statements who is willing to learn how to decipher the contents of them.

Be mindful that operational costs that follow the earnings/sales line item can contain a lot of accounts, so if you would like to see more detail or are curious to see the sub-accounts hidden within that number, you would need access to more detailed financial data. Maybe you want to look deeper into costs like insurance, labor, fuel and/or office-related overhead for greater analysis.

Sources
“Fundamentals of Financial Management, Concise Fifth Edition,” Eugene F. Brigham, Joel F. Houston.
“Intermediate Accounting, Twelfth Edition,” Donald E. Kieso, Jerry J. Weygandt, Terry D. Warfield.

Edward Morrow combines his knowledge as an accountant, arborist and author to help tree care professionals supercharge their careers. He develops engaging
urban-forestry programs for communities and created TREE S.T.A.R.S, an outdoor-adventure book series to show how important – and awesome – arborists are. Learn more at edwardthearborist.com.

This is TCI Magazine’s second look at EBITDA in recent months. For another take on this topic, see “What Business Owners Need to Know About EBITDA and the Value of Their Business,” by Ron Edmonds, in the September 2024 issue of TCI Magazine. Or go to tcimag.tcia.org and search “EBITDA.”