ADJUSTED EBITDA
Posted on Mar 10, 2023 10:44am PST
EBITDA is an acronym representing Earnings Before Interest Taxes Depreciation (and)
Amortization. It is the most widely used “income” metric to
estimate the value of a business. The formula is EBITDA times a multiple,
which equates to the expected sale price of a company. This formula is
well-understood as a rule of thumb among investment bankers and company
executives.
The “multiple” portion of the equation is developed from an
analysis of sales transactions of similarly sized companies in a particular
industry or market segment. Market data is often difficult to verify or
lacking; thus, multiples are usually stated as a range or a median within a range.
Noted below are elements which most impact EBITDA. These adjustments are
made to reflect the true earnings potential of the company, and to eliminate
any one-time or non-recurring expenses. Sellers should carefully consider
these adjustments to support the highest amount.
- Capital Expenditures – unrecognized, significant outlays for equipment
and facilities (capex) can reflect higher EBITDAs.
-
Working Capital – probably the most misunderstood aspect is the
required working capital for daily operations. There is no specific formula for
each company, so each firm must be analyzed in isolation. Key factors
are the cash needs (number of months to be covered) to balance purchases
and labor costs against revenue cycles. The higher the working capital,
the lower the EBITDA.
- Capital Leases – the International Accounting Standards Board (IASB)
requires that certain leases be capitalized. All assets and liabilities
arising from leases will be recognized on the balance sheet. EBITDA will
change, usually increasing in the early years based upon amortization
using the effective interest method. Also, EBITDA will increase now that
the operating lease expense is replaced by two components not included
in EBITDA: interest and depreciation.
- Real Estate - owned outside the business. Below market rent paid by the
company will increase EBITDA.
- Personal Expenses - paid by the company (e.g. entertainment, life insurance,
legal advice, etc.) should be added back to EBITDA.
- Owners Compensation/Benefits – in addition to normalizing the owner’s
compensation to reflect “industry norms,” salary and benefits
paid to family members not active in the business should be added back.
- Inventory Adjustments – inventory adjustments: this includes any
write-downs or write-offs of inventory, which can impact the company’s earnings.