Fundraising for nonprofits can sometimes be harder than expected. The nonprofit sector is quickly expanding, and the potential sponsors and investors are distributing their attention to various charities active in the same industry (i.e., environment, social issues, or religious organizations).
Therefore, nonprofits have to show potential benefactors or donors that their capital structure is strong enough for the non-profit organizations such as charities, social enterprises, religious organizations and other enterprises to survive in the long run. This can be done through financial reporting, but there are other metrics, such as earnings before interest, taxes, depreciation, and amortization (EBITDA) that can be taken into consideration.
This detailed article will explain what the EBITDA formula is and what it means for your nonprofit, including its definition, calculations, and why it is a crucial concept in the process of evaluating an organization, be it for-profit or nonprofit.
What Is EBITDA?
In the financial world, earnings before interest, taxes, depreciation, and amortization are referred to as EBITDA. The phrase refers to the outcome of interest, taxes, and depreciation on immaterial and fixed assets.
Due to the exclusion of all depreciation, interest expenses, interest income, and interest costs, EBITDA just indicates the outcome of an organization’s operations.
EBITDA is a useful metric for normalizing a company’s performance, so you can value and assess the firm more quickly. However, EBITDA is not a replacement for other indicators, such as net income. Because interest, taxes, and non-cash expenses are not included in EBITDA, they nonetheless have a meaningful financial impact that shouldn’t be discounted or disregarded.
If you are looking for concrete methods to use this metric, EBITDA is frequently the most helpful when comparing two companies or organizations that are similar, or when attempting to estimate a company’s cash flow potential.
Do I Need to Apply the EBITDA Formula as a Nonprofit Organization?
While, in the business world, EBITDA is mainly used as an indicator of the company’s profitability, your nonprofit organization can benefit greatly from applying this formula to understand its financial performance. Moreover, as we previously mentioned, it can also come in handy when fundraising for nonprofits.
Starting with typical EBITDA, there are multiple indicators that can help you understand the effectiveness of your current financing structure, such as the EBITDA coverage ratio.
The EBITDA coverage ratio assesses an organization’s capacity to meet its loan and lease obligations. This indicator is used to assess the solvency of heavily indebted organizations. The EBITDA and lease payments are compared to the total of its loan and lease payments to determine the ratio.
Since the EBITDA element of the ratio more closely resembles actual cash flows, it produces results that are more accurate than the time interest earned calculation.
How to Calculate EBITDA for My Nonprofit Organization
Now that you understand what’s the overall benefit of calculating this indicator and its adjacent ratios for your nonprofit organization, let’s discuss the EBITDA formula:
EBITDA = Net Income + Interest + Taxes + Depreciation + Amortization
Your statement of financial position should have all the data needed to compute the EBITDA formula. This does highlight the significance of maintaining proper financial records, though. A single error in these variables will result in an erroneous EBITDA, which could overestimate or underestimate the financial performance of your nonprofit organization.
Therefore, to make sure your finances are accurate and current when fundraising, we advise making an investment in a good accounting system or working with reliable nonprofit accountants. For a deeper understanding, we will address each component of EBITDA separately:
1. Net Income
The first element you need to take into consideration when you calculate EBITDA is the net income. This can be found in your statement of activities under this formula:
Income – Expense = Net Income (Increase in Net Assets)
This indicates that your nonprofit’s net income is equal to the sum of the money you earn minus the sum of the money you spend. This analysis will rapidly demonstrate whether your company is profitable relative to its outgoings.
Most of the time, organizations activating in the nonprofit sector call the net income “net assets”, so don’t get confused by the name, as the meaning is the same.
2. Interest
Loans to nonprofit organizations frequently involve no interest. Yet, a restricted contribution factor should be recorded to reflect the value of an interest-free loan, as they are typically not attainable through conventional financing alternatives. Additionally, using an imputed interest rate, interest expense should be recorded over the course of the loan.
The administration of the nonprofit must determine the organization’s additional cost of capital in order to calculate an imputed-interest rate. This is the predicted market interest rate that the organization may get if it were to borrow money instead.
The interest rate for an organization operating in the nonprofit sector could be calculated using the weighted average cost of capital on the existing financing. A risk-adjusted externally disclosed rate, such as the prime rate, could potentially be utilized as an estimate if the organization does not yet have any funding.
3. Taxes
An organization’s non-profit status may entitle it to perks including state sales, property, and income tax exemptions; nevertheless, there are multiple factors and eventually, additional expenses you need to take into consideration, both in the US and Canada.
Here are a couple of things to keep in mind:
In Canada, an association created and run entirely for social welfare, civic improvement, pleasure, recreation, or any other purpose other than profit is referred to as a non-profit organization under the Income Tax Act. If no portion of the organization’s income is payable to or available for a proprietor’s personal advantage, the organization will often be exempt from tax.
In the US, the nonprofit status does not automatically entitle an organization to be free from federal income tax. Most organizations must apply to the Internal Revenue Service for recognition of exemption from federal income taxes. This needs to be done in order to receive a ruling or determination letter confirming tax exemption before they can be considered tax-exempt.
4. Depreciation
The continual reduction of a fixed asset’s recorded cost until the asset’s value is zero or negligible is referred to in accounting as depreciation. In short, how much of an asset’s value has been used is shown through depreciation.
Fixed assets include buildings, furniture, office supplies, machinery, etc. As the value of land increases over time, it is the single-fixed asset that cannot be depreciated.
Typically, nonprofits apply straight line depreciation. To calculate the amount of depreciation for each year using straight line depreciation, just divide the asset’s cost by its useful life in years.
5. Amortization
A lot of your organizational, or start-up, costs when starting a nonprofit organization can be tax-deductible.
Additional expenses must be amortized over a period of 180 months and included in the deduction for the relevant year because there is a cap on your initial maximum deduction. Therefore, when calculating EBITDA, amortization simply means to spread the deductions out over time.
Zivo—Your No.1 Ally in Improving Your Nonprofit’s Financial Performance!
Managing your nonprofit’s finances can occasionally be difficult, time-consuming, and unpleasant. Especially when you have no previous experience in nonprofit accounting.
Thankfully, Zivo can ease your workload and come to your aid with the resources, assistance, and real-time financial data you need to make better decisions and improve your company’s financial performance.
Book your free consultation and let’s start working together!