Inattention to EBITDA can lead to weak balance sheets and hobble your company’s growth. But a single-minded focus on maximizing EBITDA at all costs can do just as much damage. In the end, not all EBITDA is good EBITDA, so create yours wisely.

Some companies end up with bad EBITDA by unwise cost cutting.  Nobody ever cut their way to greatness, yet the cost cutter mentality can lurk in the back of any leader’s mind. Companies will bolster profits by reducing quality, underpaying employees, or maybe just letting their company culture slide.

Through inattention and underinvestment, they fail to spend the money needed to maintain company infrastructure. Their EBITDA may show short-term gains as they cut spending, but they end up with their growth stunted and still smaller EBITDA in the long-term. A pure cost cutting mentality can lead to cutting the growth and profit out of a business over time.  Read on to hear about a great illustration of this challenge from East Coast Wings + Grill.

Another way companies get bad EBITDA is by spending unwisely, focusing only on growing their top line without controlling their costs. Fast growth in topline revenue can create EBITDA that seems positive, but only as long as you can outrun your costs.  If this works at all, it’s only in short bursts while the growth rate is high – costs catch up quickly, and this model is impossible to scale.

Bad EBITDA can come from any strategy that ignores long-term stability. These include cutting quality or service levels, things that drive up employee turnover or disengagement, even promotional pricing that kicks volume up but erodes the perception of your brand.

To create good EBITDA, companies must embrace spending money in high-value areas that are proven to drive profitable growth.

If bad EBITDA comes from short term moves that erode your brand promise, good EBITDA comes from profits that are sustainable because they flow from activities that accentuate your market differentiation. Read more about focusing on EBITDA as your success metric in my previous Forbes post here.

To find and build good EBITDA, you need to understand your business’ growth levers, then scale them through strategic spending. Here’s a 4-step process for leveraging the growth levers in any business.

1. Make a decision about where your company delivers its greatest value and is most differentiated from the competition. These are your company’s core growth levers. Prove to yourself and validate that these levers really work, in a variety of circumstances. Don’t be wrong here. If you guess at this or believe your own BS, you’ll destroy EBITDA more quickly in the next steps, rather than building it.
2. Create process around your levers—data systems, training and more. Maintain or increase spending on these levers and allow the normal lag time (that you observed when you proved these levers really work). Note:  During that lag time, EBITDA will decrease—that’s ok—you’re making an investment.
3. Cut costs and increase efficiencies everywhere else in the business. We want all our investment going toward our company’s growth levers, not being wasted in areas that don’t matter much. Target your investment for impact.
4. Measure continuously. Conditions change and differentiators get eroded over time by the competition. Work hard at breaking down ROI as much as possible to guide management’s decisions.

I recently talked with Sam Ballas from East Coast Wings + Grill about the difference between good EBITDA and bad EBITDA. East Coast Wings + Grill is a restaurant franchisor running over 40 casual dining restaurants in the southeast. The company has taken a steady, deliberate growth model for the brand to make sure its growth is built on unit-level benchmarking of sustainable EBITDA.

Sam shared a great story about a franchisee with good EBITDA who stopped investing in known best practices, damaged their EBITDA, then restored those behaviors and recovered good EBITDA.

“We have a franchisee who came aboard that’s a brilliant story of bad and good EBITDA,” Sam told me. “This individual went through the traditional franchising process. Store goes through construction, launches and they reach about $158,000 net a month, which is outperforming the average.

“Then they started taking the money out and leveraging (borrowing). They had good EBITDA, the right kind of EBITDA, but then they turn it to bad EBITDA.” Sam says the Franchisee stopped following their franchise model for investing in future growth, and their EBITDA suffered, falling well below average.

“They quit going to their stores often. They then quit doing all the community activities we had taught them to do. In six months, that good EBITDA turned to bad EBITDA because all the things that were missed or discounted.

“They were still making some money, but it’s not good EBITDA. So we get back in and we start reeducating, start retraining, giving them all the things that we told them initially as they were opening the store. You can’t expect people to come in the community and give you their money if you discount your service standards. They replaced their store level leadership.

“Within 90 days, their EBITDA turned back into what we consider good, healthy EBITDA.

“So, long story short, they turned the ship back around because they executed based on best practices, with some coaching and renewed accountability from us. And they got back to not just $158,000 but $170,000 a month.”

You could see this in anyone’s local restaurant. It starts off new and shiny with great food. They are busy. But over a few years’ time, the restaurant is not maintained, and looks worse and worse. Food portions get smaller, then quality and service decline. Soon the community turns away and the restaurant folds.

They didn’t continue to invest in what made them great. They raked in some bad EBITDA early on, but it wasn’t sustainable. They cut costs until they cut their business down to nothing.

Hating costs and being “cheap” helps the small businessperson survive. But you can’t thrive with that mindset and scale your business.

To become midsized and keep growing, you must love investing in profitable growth, but you still need to avoid waste. The biggest waste in many midsized businesses comes from scaling up things that aren’t driving your success; you end up scaling waste.

Good EBITDA comes from an investment mentality; bad EBITDA comes from a scarcity mentality.

Originally posted on Forbes online: https://www.forbes.com/sites/robertsher/2019/05/13/bad-ebitda-vs-good-ebitda/