Adjusted EBITDA (earnings before interest, taxes, depreciation, and amortization) is a financial metric that can be used to assess the health and earnings potential of a business.
Like regular EBITDA, adjusted EBITDA adds back interest, taxes, and depreciation/amortization to net income. However, it also adds/removes certain non-recurring sources of income or unusual expenses that might temporarily skew earnings. This can help investors, analysts, and business owners more accurately understand how well a company is performing compared to its industry peers.
Read on for a closer look at what adjusted EBITDA is, how it’s calculated, its pros and cons, and what it can tell you about your small business.
Key Points
• Both EBITDA and adjusted EBITA add interest, taxes, depreciation, and amortization expenses back to net income.
• Adjusted EBITDA refines standard EBITDA by removing irregular items, providing a clearer view of operational performance.
• This formula aids in comparing companies within the same industry by standardizing earnings.
• Adjusted EBITDA may be used for valuations in mergers, acquisitions, and capital raising.
• While not GAAP-recognized, adjusted EBITDA provides insights into a firm’s financial health and future earnings potential.
What Is Adjusted EBITDA?
Adjusted EBITDA builds on the standard EBITDA formula, which adds back non-operational, non-recurring, and non-cash expenses to net income to get a better sense of a firm’s operational strength. Adjusted EBITDA may also subtract any unusual expenses from net income, since they aren’t likely to occur again.
Both adjusted EBITDA and EBITDA add interest on debt (such as different types of small business loans), taxes, and the non-cash expenses depreciation/amortization back to net income to arrive at an earnings number that focuses on a firm’s operational efficiency.
Here’s a look at what EBITDA (and adjusted EBITDA) adds back and why:
• Interest: This refers to Interest on debt, such as loans for small businesses. EBITDA excludes this expense because the amount of debt a company takes on depends on the financing structure of a company.
• Taxes: Because taxes vary by region, companies with similar sales can pay significantly different amounts in taxes. This can skew their net income and make it difficult to accurately compare two companies in different locations.
• Amortization and depreciation: Depreciation spreads out the cost of a tangible asset over the course of its useful life, while amortization does the same with intangible assets, such as patents, licenses, copyrights, and trademarks. EBITDA adds these non-cash expenses back to net income because they depend on the historical investments the company has made, not on its current operating performance.
Adjusted EBITDA, however, goes one step further than EBITDA by also removing any irregular, one-time, or non-recurring income or expenses (such as redundant assets, bonuses paid to owners, rentals above or below fair market value) to further zero in on a firm’s performance and earnings potential.
It’s important to note that like EBITDA, adjusted EBITDA is not recognized by Generally Accepted Accounting Principles (GAAP).
Adjusted EBITDA Formula
The adjusted EBITDA formula is:
Net income + Interest + Taxes + Depreciation & Amortization = EBITDA
The formula for adjusted EBITDA is:
Standard EBITDA +/- Adjustments = Adjusted EBITDA
Who Uses Adjusted EBITDA & What Does It Tell You?
Analysts and investors might use adjusted EBITDA when doing a valuation of a company, while lenders might use this metric to better assess the profitability of a business applying for a small business loan.
Because it removes one-off income and expenses, a business owner might use adjusted EBITDA to get a better handle on their firm’s profitability. By excluding certain irregular items that are not likely to recur in future periods, this metric can also help owners with budgeting and forecasting.
How Does Adjusted EBITDA Work?
Adjusted EBITDA works by simply removing various one-time charges and irregular income sources from the EBITDA calculation. The goal is to find a normalized earnings figure that is not distorted by unusual activities.
Calculating Adjusted EBITDA
Calculating adjusted EBITDA vs. EBITDA is very similar — the only difference is that adjusted EBITDA adds or subtracts certain non-recurring items.
The items excluded in adjusted EBITDA can vary widely from one business to another, but some of the most common EBITDA adjustments include:
• Litigation costs
• Special donations
• One-time gains or losses
• Investments
• Maintenance and repairs expenses
• Foreign exchange income or losses
• Above-market owners’ compensation (private companies)
• Real estate expenses
• New hire expenses
(Another version of EBITDA, EBITDAR, adjusts EBITDA only by removing restructuring and rent costs.)
Recommended: What is Pre-Seed Funding?
How Is Adjusted EBITDA Used?
Adjusted EBITDA is most often used for determining the value of a company for transactions like mergers, acquisitions, or raising capital. One of the key advantages of using adjusted EBITDA vs. other metrics (such as net income, regular EBITDA, or changes in working capital) is that it levels the playing field when comparing firms within the same industry.
With small businesses, for example, owners’ personal expenses are often run through the business and need to be adjusted out. In addition, one-time expenses, such as legal fees, real estate expenses (like repairs or maintenance), or insurance claims, may need to be added back.
Pros and Cons of Adjusted EBITDA
As with any valuation tool, there are advantages and disadvantages to using adjusted EBITDA. Here’s a look at how they stack up.
| Pros of Adjusted EBITDA | Cons of Adjusted EBITDA |
|---|---|
| Provides a valuation based on regular and actual transactions | Takes knowledge and skill to identify non-operation or non-recurring expenses |
| Aids in predicting future business earnings | Not recognized by the GAAP |
| Allows analysts to compare companies apples-to-apples | Aggressive accounting techniques can result in manipulated valuation figures |
Adjusted EBITDA Example
We’ll use fictional company ABC to show how to calculate adjusted EBITDA. Here are some of the inputs found on the company’s financial statements.
Net income: $700,000
Taxes: $100,000
Interest expense: $10,000
Depreciation & amortization: $40,000
Adjustments: $50,000
To calculate standard EBITDA:
$700,000 (net income) + $100,000 (taxes) + $10,000 (interest) + $40,000 (depreciation & amortization) = $850,000 (standard EBITDA)
The next step is to find adjusted EBITDA by adding back the adjustments. Keep in mind that unusual income sources are subtracted, while unusual expenses would be added back to arrive at adjusted EBITDA. With company ABC, the adjustments are irregular expenses, so they are added back to earnings.
$850,000 (standard EBITDA) + $50,000 (adjustments) = $900,000 (adjusted EBITDA)
The Takeaway
Adjusted EBITDA is another earnings measurement of a business. It uses the standard EBITDA formula to gauge earnings from a company’s core operations, then adds or subtracts certain anomalies so that income is normalized.
While not a GAAP or small business loan requirement, knowing your company’s adjusted EBITDA can offer important clues into its financial health. It can also help you forecast future earnings and make important business decisions, such as whether or not to seek out financing to help expedite growth.
If you’re seeking financing for your business, SoFi is here to support you. On SoFi’s marketplace, you can shop and compare financing options for your business in minutes.
FAQ
Is adjusted EBITDA the same thing as net income?
No. Adjusted EBITDA starts with net income, then adds interest on debt, taxes, and depreciation/amortization expenses to come up with EBITDA (earnings before interest, taxes, depreciation, and amortization). It then adds or subtracts unusual expenses or income (so-called “adjustments”) to arrive at adjusted EBITDA.
What is considered a good adjusted EBITDA margin?
EBITDA (earnings before interest, taxes, depreciation, and amortization) margin gives you a numerical valuation expressed as a percentage:
EBITDA margin = EBITDA / Total revenue
Generally speaking, an adjusted EBITDA margin of 10% or more is considered good.
What does adjusted EBITDA tell you?
Adjusted EBITDA (earnings before interest, taxes, depreciation, and amortization) removes non-recurring, irregular, and one-time items that may distort EBITDA. It helps analysts and investors assess a firm’s earning potential and make comparisons across a variety of companies in the same industry.
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