You probably started your company because you have a unique product or passion to share with the world – and not because you’re a fan of budgets and spreadsheets. Yes, you can – and likely should – hire a CFO to handle the nitty-gritty of your finances. But it’s still important to understand some of your Key Performance Indicators, or KPIs.
Net income and EBITDA are two important KPIs that measure financial performance. It’s especially important for startups to understand the difference between the two, and to know when to use them to measure their financial success.
We know – there’s a lot of ‘alphabet soup’ to learn in the world of finance. Here’s the basics you need to understand when it comes to net income and EBITDA.
EBITDA stands for ‘Earnings Before Interest, Taxes, Depreciation, and Amortization.’ It sounds like a handful, but it’s a pretty basic concept. In brass tacks, it’s a measure of the profitability of a company. In other words, it’s how much money a company brings in, before accounting for any of its expenses: depreciating assets, amortization, cost of revenue, overheads, and interest.
Think of it like when you were a kid with a lemonade stand. When you counted out your nickels at the end of the day, that was the only number you cared about, right? You didn’t think about how much your mom spent on the lemonade and cups, or how much time you had to spend in the hot sun. You were only counting your EBITDA.
On the other hand, net income (or net earnings) are your company’s income after accounting for all those expenses EBITDA ignores. It’s all the money brought in, minus all the money that goes out, to the cost of goods, general and admin expenses, operating expenses, depreciation, interest, taxes, and the like.
Going back to our lemonade stand example, you’d care more about your net income if your mom actually made you pay her back for the lemonade, or if you have to split your earnings with the next door neighbour who helped you out all day.
The Right KPI for Your Startup
Like with most KPIs, there are times when it makes sense to use either net income or EBITDA, and times when it doesn’t.
Remember that EBITDA measures the pure profitability of a company. For this reason, it can be an extremely helpful KPI for startups, which are often looking to maximize sales, and may also be more susceptible to uncontrollable factors, given their tight budgets. Understanding your EBITDA can be great to keep track of growth.
That said, EBITDA can also overstate cashflow, so it shouldn’t be the only KPI you track. That’s why net income, which ultimately calculates earnings per share, if often a better KPI for more established companies.
The reality is that each company is unique, and navigating this ‘alphabet soup’ of finances is best done with the right guidance. In other words, CFOs are often in the best position to help you determine which KPIs are right for your startup – along with how to track them.