EBITDA Adjusted: What Is It?
Earnings before interest, taxes, depreciation, and amortization, or adjusted EBITDA, is a metric a firm calculates by taking its earnings and adding back interest costs, taxes, depreciation charges, and other adjustments.
By eliminating anomalies, EBITDA can be standardized, making the resultant adjusted or normalized EBITDA easier to compare to the EBITDA of other businesses and the EBITDA of the sector in which the company operates.
how to figure out adjusted EBITDA
EBITDA is a calculation that begins with a company’s net income. It stands for earnings before income, taxes, depreciation, and amortization. Add back interest costs, income taxes, and all non-cash expenses, such as depreciation and amortization, to this sum.
Then, either subtract any additional, normal expenses that would be included in peer companies but may not be present in the company under investigation or add back non-routine expenses like high owner’s pay. This might, for instance, include pay for necessary headcount in an understaffed organization.
What Can You Infer from Adjusted EBITDA?
Similar companies are compared and evaluated using adjusted EBITDA for valuation research and other purposes. Since different businesses may have a variety of expense elements that are particular to them, adjusted EBITDA is different from the standard EBITDA statistic in that it is used to normalize a company’s income and expenses. Compared to the non-adjusted version, adjusted EBITDA makes it simpler to compare different business units or companies in an industry by attempting to normalize income, standardize cash flows, and eliminate anomalies or idiosyncrasies (like redundant assets, owner bonuses, rentals above or below fair market value, etc.).
Smaller businesses frequently have to make adjustments for the personal expenses of the proprietors. Treasury Regulation 1.162-7(b)(3) describes the adjustment for appropriate pay to owners as “the amount that would ordinarily be paid for like services by like organizations in like circumstances.”
Other times, one-time costs like legal fees, property-related costs like repairs or maintenance, or insurance claims must be added back when calculating the adjusted EBITDA. Nonrecurring revenue and expenses, such as one-time startup costs that typically lower EBITDA, should also be added back.
When used with other analytical techniques to value a firm or group of companies, adjusted EBITDA should not be utilized in isolation. The enterprise value/adjusted EBITDA ratio is one example that may be used to compare businesses of various sizes and industries.
An Example of Using Adjusted EBITDA
The adjusted EBITDA measure is particularly beneficial when estimating a company’s value for mergers, acquisitions, or capital raising. The value of a corporation, for instance, could fluctuate dramatically following add-backs if it is evaluated using a multiple of EBITDA.
Assume a firm is being appraised for a sale transaction, and the estimated purchase price was determined using an EBITDA multiple of 6x. The company’s purchase price would increase by $6 million ($1 million multiplied by the 6x multiple) if the company had just $1 million in nonrecurring or unusual expenses to add back as EBITDA adjustments. Because of this, stock analysts and investment bankers pay close attention to EBITDA changes during these kinds of deals.
The goal is the same, yet adjustments to a company’s EBITDA might differ significantly from one to the next. The EBITDA measure adjustment aims to “normalize” the number so that it is reasonably generic and essentially has the same line-item expenses as any other comparable company in its industry.
Most of the changes are frequently various expenses re-added to EBITDA. Due to the lower expenses, the resulting adjusted EBITDA frequently shows greater earnings levels.
EBITDA Modifications Typical EBITDA adjustments are:
- Unrealized profits or losses
- Non-cash costs (amortization and depreciation)
- litigation costs
- Owner compensation that is above the average for private companies
- Foreign currency gains or losses
- impairments to goodwill
- Unrelated business income
- a salary based on shares
Although it may be for internal use exclusively, many businesses may examine adjusted EBITDA quarterly or even monthly. This statistic is often generated on an annual basis for a value review.
Analysts frequently utilize a three- or five-year average adjusted EBITDA to smooth out the data. The better, the higher the adjusted EBITDA margin. Due to variations in methodologies and assumptions used to calculate the adjustments, various companies or analysts may arrive at slightly different adjusted EBITDA figures.
While non-normalized EBITDA is frequently disclosed to the public, these numbers are frequently not. It is significant to highlight that adjusted EBITDA is not a line item on a company’s income statement that conforms to generally accepted accounting principles (GAAP).
- The non-recurring, irregular, and one-time items that could distort EBITDA are eliminated from the adjusted EBITDA measurement.
- Adjusted EBITDA gives valuation analysts a standardized figure to make comparisons across several businesses in the same industry more insightful.
- As Adjusted EBITDA is not needed in GAAP financial statements, public corporations disclose standard EBITDA in financial statement filings.