As a business owner, you are constantly comparing business performance not only to competition but to previous year earnings and performance. In merger and acquisition transactions, EBITDA is often used by companies to compare similar businesses in the same market. Understanding how to use EBITDA can help your overall performance and make sure you are prepared in the event of a business sale or purchase.
Earnings Before Interest, Taxes, Depreciation and Amortization (EBITDA) was first used as a general measure of cash from operations while stripping out factors such as interest, tax, depreciation and Amortization to allow analysts to compare companies on an Apples-to-Apples basis. It is important in assessing the performance of the firm over time compared to industry benchmarks. It is also a key valuation measure for developing the sale price or valuation of a business.
EBITDA can be calculated in one of two ways. The first is by adding operating income and depreciation and amortization together. The second is by adding taxes, interest expense, and depreciation and amortization to net income.
What does “adjusted” mean, when I hear the term adjusted EBITDA?
The adjusted EBITDA measurement removes non-recurring, irregular and one-time items that may distort EBITDA. Adjusted EBITDA provides valuation analysts with a normalized metric to make comparisons more meaningful across a variety of companies in the same industry. When buyers evaluate the acquisition of a company, the Adjusted EBITDA is the driving factor to help assess the business on the financial side of things. Please note that buyers and sellers have lengthy negotiations and discussions on how EBITDA should be adjusted. Working with a qualified advisor who can assist in this process can help an owner maximize value.
Examples of “adjustments” to your EBITDA
- Club and association fees that will be replicated or removed with a new buyer;
- Owner’s car expenses (monthly payment, insurance, gas, and so on);
- Travel, meals, entertainment that will not continue post-sale;
- Adjustments to owner’s compensation;
- Overcompensated employees or employees that will no longer be with the company post-sale;
- Asset impairment charges or write-offs;
- Underpriced rent;
- Losses from discontinued operations;
- Losses from early retirement of debt;
- M&A or divestiture-related expenses;
Losses from the sale of assets;
Abnormal legal costs;
- Natural disaster damage costs;
- Charges stemming from changes in accounting policy; and
- Restructuring charges inclusive of severance pay and factory closings.
Why are highlighted non-recurring expenses important when you are selling your business?
Non-recurring expenses are specifically designated on a company’s financial statements as an extraordinary or one-time expense the company does not expect to continue over time, at least not on a regular basis.
Such expenses may significantly skew a company’s profitability for the entire accounting period and can be backed out to show higher valuation for long-term projection/planning purposes.
Selling a business is often one of the most daunting decisions of people’s lives outside of medical and major life events. There are countless emotions, time, and relationships that have been developed running and building that business.
Understanding how your Adjusted EBITDA is calculated and negotiated is a key metric when determining the value of your business’s total enterprise value on a purely quantitative or financial basis. Other factors that will help shape the value from buyers will be your strategic location, growth area, government tax policy, key personnel, vendor relationships and diversification of customers to name a few.
Although adjusted EBITDA is a key metric, you will only know the value of your business after you have received numerous offers. We have assisted numerous distribution businesses in understanding their Adjusted EBITDA and finding a business’s true value in the open market while going through the sales process.