Understanding Adjusted EBITDA vs. EBITDA for Valuation

Are you confused about using EBITDA or adjusted EBITDA when valuing your business? What’s the difference between the two?

We've found that while both metrics are ideal for valuing a business, one is more suitable for sell-side business valuations, while the other is preferred by the buy-side when evaluating target businesses. 

In this adjusted EBITDA vs. EBITDA guide, we discuss the impact of each metric on your business's valuation, its limitations and advantages, and which one to use when valuing a business for sale. 

TL;DR - Difference Between EBITDA and Adjusted EBITDA

Let's start with a quick overview between EBITDA and adjusted EBITDA:

When selling your business, both EBITDA and adjusted EBITDA come in handy. Calculating the EBITDA is pretty straightforward, but getting the adjusted EBITDA calculation right can be tricky.

To make valuing your business easier, you'll want to work with M&A experts such as financial accountants, wealth advisors, and investment bankers. 

We at Exitwise can connect you with the best M&A experts who specialize in your industry. These experts can help you calculate each metric correctly and decide which one to use when valuing and selling your business to get the highest possible sale price. 

Chat with our team today to achieve the exit of your dreams. 

What Is EBITDA?

EBITDA is a metric used to determine a business's operating profitability during a valuation for raising capital or selling it.

The acronym stands for “Earnings Before Interest, Taxes, Depreciation, and Amortization". 

You can use EBITDA to measure the ability of your business to earn profit from its core operations. To do this, you have to remove depreciation and amortization (non-cash expenses) and interest and taxes (non-operational items).

Why Is EBITDA Important?

As one of the most common business valuation metrics, EBITDA is important in several ways:

• The metric clearly shows a business's profitability by excluding the impact of aspects like interest, taxes, and non-cash expenses on earnings.

• EBITDA allows investors, business owners, and other stakeholders to compare similar businesses more accurately, regardless of their tax and capital structures.

• EBITDA can help evaluate a business's ability to generate cash flow from its core operations, even if it doesn't measure cash flow directly.

• Stakeholders can use EBITDA to evaluate how well a business manages its daily operations since it excludes aspects outside the core business activities. 

Components of EBITDA

As the acronym suggests, EBITDA has five components:

1. Net Income: These are the earnings that remain when you subtract the cost of goods sold and operating expenses from revenue. 

2. Interest Expense: This comes from the money the business has borrowed to fund its core operations. 

3. Taxes: The tax implications of your business activities vary depending on your income and the location where your business operates. 

4. Depreciation: This is a non-cash expense due to the loss of value caused by wear and tear on tangible assets, such as machinery. 

5. Amortization: Similar to depreciation, but is a non-cash expense that applies to intangible assets like patents and copyrights because they have a limited useful life. 

What Is a Good EBITDA Margin?

Expressed as a percentage, EBITDA margin refers to the ratio of EBITDA to net revenue. 

EBITDA Margin = EBITDA ÷ Net Revenue

The ratio is used to determine the percentage of every dollar of revenue that trickles down into EBITDA. You can use it to measure your business's operational efficiency in producing sustainable profits. 

EBITDA margins can vary between industries, but it's generally accepted that above 10% is a good margin, while above 20% is seen as excellent. 

What Is Adjusted EBITDA?

Adjusted EBITDA is an improved financial metric that measures a business's operating profitability by normalizing EBITDA by removing irregular or one-time items.

The idea is to build on traditional EBITDA by excluding additional non-recurring or non-operational items to create a more accurate picture of a business's ongoing operational performance and sustainable profitability. 

Significance in Financial Analysis

Adjusted EBITDA is a better measure of sustainable earnings and profitability than EBITDA. The metric offers a more refined overview of earnings once you remove additional items that do not reflect the business’s usual, ongoing operations. 

Additionally, adjusted EBITDA is better for comparing various businesses within the same industry. The metric is more accurate after removing items that may distort EBITDA because of their uniqueness to each company. 

Common Adjustments Made to EBITDA

There is no standard list of the items to be included or excluded when calculating adjusted EBITDA. 

You may have to consider the following items and more, depending on your situation:

• Litigation expenses

• Goodwill impairments 

• Unrealized gains or losses

• Non-recurring gains or losses 

• Non-operating income or expenses

• Above-market owner's compensation in private businesses 

• Rentals above or below fair market value 

• Foreign exchange losses or gains

• Assets write-downs

• Special donations

• Understaffing

What Is a Good Adjusted EBITDA Margin?

Like EBITDA margin, anything above 10% is considered a good adjusted EBITDA margin, and anything above 20% is considered great. 

Here's the formula:

Adjusted EBITDA Margin = (EBITDA ± Adjustments) ÷ Net Revenue

EBITDA vs. Adjusted EBITDA — Key Differences

The key difference between EBITDA and adjusted EBITDA is the number of adjustments made:

• In EBITDA, the only exclusions or “adjustments" to earnings are interest, taxes, depreciation, and amortization. 

• Adjusted EBITDA includes additional adjustments for one-time or non-operational items such as legal expenses and restructuring costs. 

Calculating EBITDA and Adjusted EBITDA

Let's check out how you can calculate EBITDA and adjusted EBITDA for your business. 

How to Calculate EBITDA

Here's the EBITDA formula:

EBITDA = Net Income + Interest + Taxes + Depreciation + Amortization

Let's assume you are valuing a restaurant business with the following metrics:

• Annual net income: $6.5 million

• Interest expense: $500,000

• Taxes: $800,000

• Depreciation and amortization: $1,000,000

EBITDA = $6.5 million + $500,000 + $800,000 + $1,000,000 = $8,800,000

Once you have calculated the EBITDA for the current and last few years, you can use the free Exitwise valuation calculator to estimate how many times your business is worth its EBITDA. 

How to Calculate Adjusted EBITDA

While you start with earnings in an EBITDA calculation, an adjusted EBITDA calculation begins with the EBITDA. 

Here's the adjusted EBITDA formula:

Adjusted EBITDA = EBITDA ± Adjustments

Assuming the restaurant business above had the following non-recurring items, the adjusted EBITDA will be calculated as below:

• Legal fees: $200,000

• Restructuring costs: $600,000

• Goodwill impairment expense: $12,000

• Gain from asset sale: $10,500

Adjusted EBITDA = $8,800,000 + $200,000 + $600,000 + $12,000 - $10,500 = $9,601,500

Note: We subtract a gain from an asset sale when calculating adjusted EBITDA because the focus is on a business's core operating performance, and gains from an asset sale are typically one-time, non-operating income. Adding the gain rather than subtracting it would inflate the adjusted EBITDA.

Advantages and Limitations of Each Metric

Let's now see how the two metrics are helpful or practically limited:

EBITDA Advantages and Limitations

EBITDA has two key advantages:

1. The metric is a quick way to see the overall profitability of your business. 

2. Calculating EBITDA is easy because the exclusions are straightforward and accessible from your business's income statement. 

However, EBITDA has several limitations:

• Since it overlooks capital structure, it can yield incorrect or unfair comparison results. For example, two or more companies can have the same EBITDA but differ in leverage. One can be more operationally efficient, meaning a better ability to convert revenue into earnings. The other could be using most of its revenue to repay debt, resulting in lower profitability despite its EBITDA being at par with its peers. 

• The metric may also hide high-interest financial burdens, such as loans, which could reduce your business's appeal to potential buyers or investors. 

Adjusted EBITDA Advantages and Limitations 

Adjusted EBITDA has two key advantages:

1. The metric measures the operating profitability and financial performance of a business more fairly, including showing a better picture of its ability to sustain earnings and profits. 

2. Adjusted EBITDA can promote transparency and confidence between a business seller and potential buyers because the seller must show and justify their adjustments. Agreeing on the adjustments can be easier this way. 

Like EBITDA, adjusted EBITDA has limitations:

• There is no universally agreed-upon list of what can be included or excluded as adjustments, meaning deals can easily fail if the buyer and seller don't agree on the items. 

• Adjusted EBITDA can be manipulated as businesses can make highly subjective adjustments to show a more favorable financial picture. 

Both EBITDA and adjusted EBITDA have one key common limitation. The two metrics aren't usable alone for business comparisons and valuations. You must use them alongside other valuation metrics or methods. 

Unsure which method to use for your business? You can get the help of M&A experts to apply different valuation methods and harmonize the results into an acceptable valuation asking price. 

When you work with us at Exitwise, we can help you recruit and work with the best industry-specific M&A experts to help you value your business accurately and even sell it at the best price possible.

Schedule a consultation with us today to streamline the valuation and sale process. 

Choosing Between EBITDA vs. Adjusted EBITDA in Valuation

Both EBITDA and adjusted EBITDA are useful when valuing a business for sale. You can use EBITDA as a seller because it yields a higher multiple (enterprise value: EBITDA ratio), which can mean a higher sale price. 

Potential business buyers or investors prefer adjusted EBITDA because it shows a better picture of your business's ability to produce sustainable earnings and profits. 

Adjusted EBITDA produces a lower enterprise value: adjusted EBITDA ratio (adjusted EBITDA multiple). However, you can still get a high sale price as adjusted EBITDA gives buyers a clearer picture of the business's sustainable earning potential. 

Simply put, you may not have to choose between the two metrics in an M&A transaction. You can show both to potential buyers and use them to agree on the best sale price. 

Frequently Asked Questions (FAQs)

Here are answers to common questions about EBITDA and adjusted EBITDA:

Is Non-GAAP EBITDA the Same as Adjusted EBITDA?

Non-GAAP EBITDA is not the same as adjusted EBITDA. Non-GAAP EBITDA means EBITDA calculated without following Generally Accepted Accounting Principles (GAAP), with the only exclusions being depreciation and amortization.

Adjusted EBITDA refers to EBITDA that has been modified further by removing one-time or irregular items to normalize a business's profitability. It is also a non-GAAP EBITDA metric but with more exclusions or adjustments, such as on-time gains from an asset sale.

Which Industries Benefit From Using Adjusted EBITDA vs. EBITDA?

Industries with high variability in one-time expenses, such as real estate, healthcare, retail, and technology, can benefit more from using adjusted EBITDA than traditional EBITDA in valuations. 

Is Adjusted EBITDA Higher or Lower than EBITDA?

Adjusted EBITDA is typically higher than traditional EBITDA because most of the adjustments are added back rather than subtracted. 

For example, one-time gains are subtracted, but the effect can be minimal if the add-backs are significantly higher in value. 

Conclusion

Calculating EBITDA can be easy, but determining the items to include or exclude when calculating adjusted EBITDA can be tricky. 

Justifying these additional items to potential buyers can also be challenging. While choosing between the two metrics may not be necessary, agreeing on the best sale price can also be challenging. 

To help you out, Exitwise can connect you with the right M&A experts in your industry to guide you through the valuation and sale process. This will allow you to sell at the best value and faster. 

Get in touch with us today to learn more!