What is adjusted EBITDA?
Adjusted EBITDA (earnings before interest, taxes, depreciation and amortization) is a measure calculated for a business that takes profits and adds interest expense, taxes and depreciation charges, as well as other adjustments to the measure.
Adjusted EBITDA is used to measure and compare related companies for valuation analysis and other purposes. Adjusted EBITDA differs from the standard EBITDA measure in that a company’s adjusted EBITDA is used to normalize its revenues and expenses, since different companies may have different types of expense items that are specific to them.
Normalizing EBITDA by removing anomalies means that the resulting adjusted or normalized EBITDA is more precisely and easily compared to the EBITDA of other companies and to the EBITDA of the industry as a whole. .
Key points to remember
- Measuring adjusted EBITDA removes non-recurring, irregular and punctual items that can distort EBITDA.
- Adjusted EBITDA provides valuation analysts with a standardized measure to make comparisons more meaningful between various companies in the same industry.
- Public companies report standard EBITDA in the financial statements since Adjusted EBITDA is not required in GAAP financial statements.
The adjusted EBITDA formula is
TheNOTI+IT+reA=EBITreAEBITreA+/–A=adjusted EBITreAor:NOTI = Net revenueIT = Interest and taxesreA = Depreciation and amortizationTheThe
How to calculate adjusted EBITDA
Start by calculating EBITDA, which starts with the net income of a business. To this figure add interest expense, income taxes and all non-cash costs, including depreciation and amortization.
Then either add non-recurring expenses, such as excessive compensation to the owner, or deduct any typical additional expenses that would be present in peer companies, but may not be present in the analyzed company. This could include salaries for the necessary staff in a company that is understaffed, for example.
What does adjusted EBITDA tell you?
Adjusted EBITDA, as opposed to the unadjusted version, will attempt to normalize revenues, normalize cash flows and eliminate anomalies or peculiarities (such as redundant assets, bonuses paid to owners, higher rents or less than fair market value, etc.), which makes it easier to compare multiple business units or businesses in a given industry.
For small businesses, owners’ personal expenses are often managed by the business and need to be adjusted. The adjustment for reasonable compensation to owners is defined by Treasury Board Regulations 1.162-7 (b) (3) as “the amount that would normally be paid for similar services by similar organizations in similar circumstances”.
Other times, one-time expenses must be added, such as legal fees, real estate expenses such as repairs or maintenance, or insurance claims. Non-recurring income and expenses such as one-time start-up costs that generally reduce EBITDA must also be added when calculating adjusted EBITDA.
Adjusted EBITDA should not be used in isolation and makes more sense as part of a suite of analytical tools used to assess one or more companies. Ratios based on adjusted EBITDA can also be used to compare companies of different sizes and in different industries, such as the adjusted enterprise value / adjusted EBITDA ratio.
Example of use of adjusted EBITDA
The measure of adjusted EBITDA is very useful when used to determine the value of a business for transactions such as mergers, acquisitions or raising capital. For example, if a business is valued using a multiple of EBITDA, the value can change significantly after the buyouts.
Suppose a company is evaluated for a sales transaction, using an EBITDA multiple of 6x to arrive at the estimate of the purchase price. If the company has only $ 1 million of non-recurring or unusual expenses to add as EBITDA adjustments, this adds $ 6 million ($ 1 million multiplied by the multiple of 6) to its price of purchase. For this reason, EBITDA adjustments are subject to close scrutiny by stock analysts and investment bankers in these types of transactions.
Adjustments to a company’s EBITDA can vary considerably from one company to another, but the objective is the same. The adjustment to the EBITDA measure aims to “normalize” the figure so that it is somewhat generic, which means that it contains essentially the same item expenses as any other similar company in its industry would contain.
The bulk of the adjustments are often different types of expenses that are added to EBITDA. The resulting adjusted EBITDA often reflects a higher level of profit due to the reduction in expenses.
Current EBITDA adjustments include:
- Unrealized gains or losses
- Non-monetary expenses (depreciation, amortization)
- Litigation costs
- Owner compensation above market average (in private companies)
- Exchange gains or losses
- Goodwill impairment
- Non-operating revenue
- Stock-based compensation
This measure is typically calculated on an annual basis for valuation analysis, but many companies will review adjusted EBITDA on a quarterly or even monthly basis, although it may be for internal use only.
Analysts often use an average adjusted EBITDA over three or five years to smooth the data. The higher the adjusted EBITDA margin, the better. Different companies or analysts may arrive at a slightly different adjusted EBITDA due to differences in their methodology and assumptions when adjusting.
These figures are often not made available to the public, while non-standardized EBITDA is generally public information. It is important to note that adjusted EBITDA is not a standard element of generally accepted accounting principles (GAAP) in a company’s income statement.