How to Calculate Adjusted EBITDA
EBITDA stands for Earnings before Interest, Tax, Depreciation, and Amortization. In terms of determining business value most buyers of small businesses use a multiple of EBITDA to determine a small business’s value. Buyers use EBITDA because it is a measure of the financial performance of the business that is not impacted by tax regime or capital structure.
Still most buyers change EBITDA to better reflect the true performance of the business. To make these adjustments they add or take away certain expenses. Most multiples referenced by a buyer are on an adjusted EBITDA.
To calculate your firm’s adjusted EBITDA, follow the steps below.
1. Take net income (or the equivalent thereof) from financial statements
2. Add: Interest payments to bank loans, credit cards, and institutional financing sources
3. Add: Income tax payment (Do not add excise taxes, taxes tied to the cost of goods sold, sales tax, employment taxes, payroll taxes, etc.)
4. Add: Depreciation expenses recognized by the IRS (What is depreciation?: http://www.investopedia.com/terms/d/depreciation.asp)
5. Add: Amortized expenses recognized by the IRS (What is an amortized expense?: http://www.accountingtools.com/amortization-expense)
6. Add: Personal expenses such as cars, meals, trips, and cell phones.
7. Subtract or Add: Change your lease to a fair market value.
8. Add: Non-recurring expenses that are not related to CAPEX (What is CAPEX?: http://www.investopedia.com/terms/c/capitalexpenditure.asp)
9. Subtract: Non-recurring income (Primarily this non-recurring income is referring to income that is unlikely to be representative of the future performance of the business. For example, the business won a large contract, but will not likely win a similar contract in the future.)
10. Subtract: Maintenance CAPEX (If the maintenance CAPEX is not reflected in the operations of the business, you should determine this figure and subtract it from EBITDA. Maintenance CAPEX is the necessary expenditures required to keep existing operations running smoothly. Perhaps a new conveyor belt for the old machine, or new computers to replace the outdated technology. These expenses don’t attract new customers or create the capacity for a bigger business; they just enable the company to keep running at status quo.)
11. Subtract: What insurance should you have that you don’t? What is the annual cost? Subtract the cost of these insurance plans from EBITDA. Every business and industry has slightly different insurance needs.
12. Subtract: Missing expenses such as under or uncompensated workers, cost of storage, cost of client relationship upkeep, etc.