There is a lot of discussion in the M&A world about EBITDA and a wide variety of opinions about what is included and what is not included. Because of this, many advisors, sellers, and buyers are using an “adjusted” EBITDA figure for sales transactions. How do EBITDA and “adjusted” EBITDA differ? This is part 1 of a 3-part series about the important metric we call EBITDA.
Calculating EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization) may seem like a simple thing to do, but there are many factors that come into play that aren’t part of an over-simplified calculation. These include: owner wages, replacing the owner, perks, excess wages, discretionary expenses, partners and their roles, etc.
Let’s begin with the baseline number: Earnings. Earnings has many titles including: Sales, Gross Profit, Net Income, Taxable Income, etc. It is easy to get confused by these titles and not understand the true meaning of the word as it pertains to EBITDA. In a recent transaction I had a business owner who “swore” his business was worth 1.5x Earnings. He had understood Earnings to mean Gross Sales, not EBITDA. He was using the right multiple with the wrong number for Earnings. Here is a list of where you can find “Earnings’ to use as a baseline for calculating EBITDA:
- Form 1120 S (S-corp). Ordinary Business Income – Line 21
- Form 1065 (LLC/Partnership). Ordinary Business Income – Line 22
- Form 1120 (C-corp). Taxable Income – Line 30
- Net Income from an internally generated P&L
- Schedule C – Net Profit or Loss – Line 31
- Income Before Taxes on an Income Statement. Interest.
Once you have a good starting number you can proceed to Step 2 of calculating EBITDA. This will be covered in Part 2 of this series.