What is Adjusted EBITDA?
Adjusted EBITDA (earnings before interest, taxes, depreciation, and amortization) is a measure that takes a company’s earnings and adds back interest expenses, taxes, and depreciation charges, plus other specific adjustments. This standardization eliminates anomalies, making the resulting adjusted or normalized EBITDA more accurate and comparable across different companies and industries.
Key Takeaways
- Adjusted EBITDA removes non-recurring, irregular, and one-time items that distort the standard EBITDA.
- It provides analysts with a normalized metric for meaningful comparisons within industry sectors.
- Public companies do report standard EBITDA in their financial statement filings as Adjusted EBITDA is not required by GAAP.
The Formula for Adjusted EBITDA
Adjusted EBITDA = Net Income + Interest + Taxes + Depreciation + Amortization + Adjustments
where:
- Net Income (NI)
- Interest & Taxes (IT)
- Depreciation & Amortization (DA)
- Adjustments
How to Calculate Adjusted EBITDA
Start by calculating earnings before income, taxes, depreciation, and amortization (EBITDA) from a company’s net income. Add back interest expense, income taxes, and non-cash charges like depreciation and amortization. Next, either add back non-routine expenses or deduct typical expenses that your company lacks but peers have. This could include salaries for necessary roles in an under-staffed company.
What Does Adjusted EBITDA Tell You?
Adjusted EBITDA is vital for comparing valuations among related companies. By normalizing income and standardizing cash flows, it eliminates anomalies. For smaller firms, personal expenses run through the business need adjusting.
Non-recurring expenses, like legal fees or insurance claims, should be added back, along with startup costs. Adjusted EBITDA shouldn’t be used alone but should complement other analytical tools. Ratios like enterprise value/adjusted EBITDA enable comparison across different industries.
Real-World Example of Using Adjusted EBITDA
Consider a scenario where you’re valuing a company for a sale with an assumed EBITDA multiple of 6x. Adding back $1 million of non-recurring expenses can significantly increase the purchase price by $6 million (i.e., $1 million times 6x). Such adjustments can impact a company’s valuation dramatically.
Common EBITDA Adjustments
Common EBITDA adjustments include:
- Unrealized gains or losses
- Non-cash expenses (depreciation, amortization)
- Litigation expenses
- Owner’s above-market compensation (in private firms)
- Gains or losses on foreign exchange
- Goodwill impairments
- Non-operating income
- Share-based compensation
This metric is typically calculated annually but can also be reviewed quarterly or monthly for internal purposes. Analysts often use an average adjusted EBITDA over several years to smooth out data variation.
Although adjusted EBITDA figures are valuable, note that they usually remain unavailable to the public; non-adjusted EBITDA is publicly accessible. Also, adjusted EBITDA isn’t a GAAP-standard line item on income statements.
Related Terms: EBITDA, normalized earnings, enterprise value, merger, acquisition.
References
- Gilson, Stuart C., Hotchkiss, Edith S., and Ruback, Richard S. “Variation of Bankrupt Firms”. The Review of Financial Studies, vol. 13, no 1, Spring 2000. pp. 49.
- Code of Federal Regulations. "§ 1.162-7 Compensation for Personal Services".
- U.S. Securities and Exchange Commission. “EBITDA: Financial Contract Definitions”.
- Financial Industry Regulatory Authority. “Investment Banking Representative Qualification Exam (Series 79)”, Page 4.
- Liu, Jing, Nissim, Doron, and Thomas, Jacob. “Equity Valuation Using Multiples”. Journal of Accounting Research, vol. 40, no 1, March 2002, pp. 154.
- U.S. Securities and Exchange Commission. “Non-GAAP Financial Measures”.
