WHAT THE HECK IS EBITDA?
Updated: Mar 4, 2022
Depending on what part of the country you live in, it is pronounced differently – but it means the same thing. It is Earnings before interest, taxes, depreciation and amortization. To say that in English: It’s the income the business is generating before paying for the capital it takes to buy it, equip it or pay income taxes.
This is typically what buyers use to value most businesses. A multiple of the cash flow the business is generating. Businesses can be valued anywhere from 2 to 20 times EBITDA based on many factors which we will deal with in another post. Most small and medium sized businesses trade for between 3 and 8 times EBITDA. Determining EBITDA is a simple calculation based on your income statement or P&L. You take the bottom line and add back those 4 items: interest expense, income taxes, depreciation and amortization expense.
Now you know what your EBITDA is!
What is “recast” or “normalized” EBITDA?
Before using your EBITDA number for valuing your business, we should “normalize” it or “recast” it. This removes the “personal” or “will not be spent by the new owner” expenses. Typical items include charitable contributions, excess wages to the owner or family members of the owner, vehicles and insurance used by the owner…you get the picture. Sometimes there are one time adjustments like PPP loan forgiveness, one time contract income or expenses. The idea is to give the Buyers a fair picture of what the business would have done if they had owned the business.
Another common recast item occurs when the business pays rent to the owner of the business who owns the facility. Many times this rent is not market rent and so it has to be adjusted based on market rates.
Once you have a more accurate or “recast” EBITDA, care needs to be taken to document all the “recast” items so that Buyers can compare the results to the historical financial statements to see if they agree with the recast number. This avoids surprises after agreeing to a multiple of EBITDA in an LOI, the Buyer doesn’t agree with your recasting!