What Is Adjusted EBITDA?
Let me explain Adjusted EBITDA to you directly—it's earnings before interest, taxes, depreciation, and amortization, a measure I calculate for a company by taking its earnings and adding back interest expenses, taxes, depreciation charges, and other adjustments.
When you standardize EBITDA by removing anomalies, the resulting adjusted or normalized EBITDA becomes more accurate and easier to compare with the EBITDA of other companies, or even to the overall EBITDA in a company's industry.
Key Takeaways
You should know that the adjusted EBITDA measurement removes non-recurring, irregular, and one-time items that might distort standard EBITDA.
It provides valuation analysts with a normalized metric, making comparisons more meaningful across various companies in the same industry.
Public companies report standard EBITDA in their financial statement filings, but adjusted EBITDA isn't required under GAAP.
The Formula for Adjusted EBITDA
Here's the straightforward formula: Start with NI + IT + DA = EBITDA, then EBITDA + / - A = Adjusted EBITDA, where NI is net income, IT is interest and taxes, DA is depreciation and amortization, and A stands for adjustments.
How to Calculate Adjusted EBITDA
To calculate it, begin with earnings before income, taxes, depreciation, and amortization—that's EBITDA—which starts from a company's net income. Add back interest expense, income taxes, and all non-cash charges like depreciation and amortization.
Next, add back non-routine expenses, such as excessive owner's compensation, or deduct any additional typical expenses that peer companies would have but aren't present in the company you're analyzing. For instance, this could include salaries for necessary staff in an under-staffed company.
What Does Adjusted EBITDA Tell You?
Adjusted EBITDA helps you assess and compare related companies for valuation analysis and other purposes. It differs from standard EBITDA because it normalizes income and expenses, accounting for unique expense items that vary between companies.
Unlike the non-adjusted version, adjusted EBITDA normalizes income, standardizes cash flows, and eliminates abnormalities or idiosyncrasies like redundant assets, owner bonuses, or rentals not at fair market value, making it simpler to compare business units or companies in an industry.
For smaller firms, owners often run personal expenses through the business, and you need to adjust those out. The adjustment for reasonable owner compensation follows Treasury Regulation 1.162-7(b)(3), defined as the amount paid for similar services by similar organizations in similar circumstances.
Sometimes, you add back one-time expenses like legal fees, real estate repairs or maintenance, or insurance claims. Non-recurring income and expenses, such as one-time startup costs that reduce EBITDA, should also be added back for adjusted EBITDA.
Don't use adjusted EBITDA alone; it fits best as part of a broader set of analytical tools for valuing companies. You can also use ratios based on it to compare companies of different sizes and industries, like the enterprise value to adjusted EBITDA ratio.
Example of How to Use Adjusted EBITDA
This metric proves most helpful when determining a company's value for transactions like mergers, acquisitions, or raising capital. For example, if you value a company using a 6x EBITDA multiple, adding back $1 million in non-recurring expenses as adjustments adds $6 million to the purchase price.
That's why equity analysts and investment bankers scrutinize EBITDA adjustments closely in these transactions. Adjustments can vary between companies, but the goal remains to normalize the figure so it's generic, containing the same essential expenses as any similar company in the industry.
Most adjustments involve adding back different types of expenses, which often results in a higher earnings level due to reduced expenses.
EBITDA Adjustments
- Unrealized gains or losses
- Non-cash expenses (depreciation, amortization)
- Litigation expenses
- Owner's compensation that is higher than the market average (in private firms)
- Gains or losses on foreign exchange
- Goodwill impairments
- Non-operating income
- Share-based compensation
Final Notes on Adjusted EBITDA
You typically calculate this metric annually for valuation, but many companies review it quarterly or monthly for internal use. Analysts often use a three-year or five-year average to smooth the data—the higher the adjusted EBITDA margin, the better.
Different firms or analysts might reach slightly varying adjusted EBITDA figures due to methodology and assumption differences. These figures usually aren't public, unlike non-normalized EBITDA, and remember, adjusted EBITDA isn't a GAAP-standard item on income statements.
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