Introducing the Concept of “REALBITDA”

    

One of the most popular financial metrics used in businesses is EBITDA. EBITDA stands for Earnings realbitdaBefore Interest, Taxes, and Depreciation. For most managers, they understand it as a metric that measures profit and provides insights into the “controllables” of a business or business unit.

The foundational idea is that most Line Managers control the drivers of profit starting at the top of the P&L, Revenues. Revenues of course is driven by selling products or services to customers. They also control the other elements such as the costs of goods sold (COGS), and the operating expenses of the business including the Marketing budget, the Sales budget, the R&D budget, Manufacturing costs, HR costs, and IT costs. Line Managers typically don’t control decisions that impact interest (borrowing money) and investments in capital equipment (CAPEX) that will show up on the P&L as Depreciation.  They also don’t control the details of big picture things such as acquisitions or how much a company may “overpay” to buy another company which would impact amortization and Goodwill on the Balance Sheet.

I was recently explaining the concepts of EBITDA in one of our Business Acumen programs and we were having a great discussion about it because every manager in the room has EBITDA in their balanced scorecard.

The next morning, during our reflections of the previous day, one of our participants wanted to challenge the EBITDA conversation and shared that he had come up with a new concept he was calling “REALBITA.”

Intrigued, I asked him to explain, “Well, I’m just a middle-level manager. I don’t set our company strategy, I just execute it. Our strategy is Product Leadership and we spend over 8% of our revenues on developing new products even though those products may not generate revenue for 3-7 years.  I also know the next nearest competitor spends about 5% of revenue on R&D which makes our investments even more impactful. And that’s not all. Many of our operating expenses that I “control” are higher because they all support future growth. To me and the way I think about it is the REALBITDA is our earnings before interest, taxes, depreciation and amortization plus any cost over and above the cost of doing business in the current fiscal year.”

He further explained an example, “Let’s say that my business unit’s revenues in 2019 were $100 million. The COGS is $29 million giving us a gross margin of $71 million.  From an operating perspective, we spend $6 million on Marketing, $8 million on Sales, $10 million on R&D, and so on giving us an EBITDA of $20 million.

However, about $6 million of our operating budget is spent solely on strategic investments that have nothing to do with today or tomorrow and if we cut them out, they would have zero impact on the current business.  Therefore, our REALBITA, the true profitability of the current business is $26 million.”

Another participant jumped in and added some additional insights, “To be very open with everyone, we also have quite a few people in our company who aren’t pulling their weight and should be adding a lot more value to the business. But HR won’t let us fire them, or they say we have to give them more time to develop.  I bet there’s another $5 million in wasted salaries that also should be added to the REALBITA that shows the real profit of the business.”

While there is an interesting case to be made for REALBITA when thinking about innovative companies that are developing and selling market leading products and services, what about businesses that are executing Customer Intimacy or Operational Excellence?

Customer Intimacy is defined as having a deep understanding of your customer’s business and delivering high levels of service and customization. When applying the rule REALBITA there is just a little extra that if it wasn’t there, most likely wouldn’t have a big impact. For example, I was staying in a hotel I usually frequent because they still deliver a choice of newspapers to your door every morning. For me and other Boomers, it’s a nice touch.  However, if they decided one day it was just too expensive and cut the service I would understand and it most likely wouldn’t impact my decision to stay there or not.  So, I think the impact of REALBITA to a customer intimate company is minimal.

Operational Excellence is defined as driving costs out of the system to so you can offer the lowest possible price in your market.  There are literally no extra costs that could be added back to REALBITA.  But, should something be subtracted from REALBITDA?  What if your Operational Excellence strategy is starving the business and putting it in a very vulnerable situation for the near future?  I propose that too much operational excellence can potentially put a business at risk and that REALBITA is penalized if foundational spending on things like Marketing, Sales, R&D, and people are significantly under invested in (below a basic and reasonable threshold even for a cost player.)

In summary, REALBITA sounds like a great idea to think about in terms of the way businesses execute strategy and I think in this day and age of “Moneyball” and other analytics, it’s something that is worth pursuing further.

Why Business Acumen Matters

Robert Brodo

About The Author

Robert Brodo is co-founder of Advantexe. He has more than 20 years of training and business simulation experience.