EBITDA stands for “Earnings Before Interest, Taxes, Depreciation, and Amortization”. The business sale price paid by buyers is generally a multiple of EBITDA, often adjusted for unusual compensation and benefits, then normalized to align with market based benefits and compensation required to operate the business. Although it is best to work with a professional to determine the final calculation of adjusted EBITDA and business sale price, an owner can estimate this figure by following the simple steps below. Ultimately, the rationale behind the adjusted EBITDA needs to be defendable to prospective buyers and may be negotiated through the sale process.
1. Tax returns. Pull out your tax returns for the years you’d like to calculate adjusted EBITDA for, using the last three years is common. Perform the steps below for each year you select separately, each tax year will have its own adjusted EBITDA.
2. Add it up. Using the first page of your tax returns:
a. Find ordinary business income (pre-tax earnings)
b. Add Interest Expense
c. Add Depreciation Expense
d. Add Amortization Expense (this may be listed in the itemized expense statement further back in the tax return)
Note: Since we are using ordinary business income from tax returns as our base number, taxes haven’t been deducted and therefore do not need to be added back.
3. Unusual Expenses. Now that you’ve found EBITDA in Step 2, review your expenses for the period you’re calculating adjusted EBITDA for. Were there one-time and non-recurring expenses? Identify any unusual expenses you don’t see year to year and add them to your EBITDA. For example, charitable donations, excessive travel and entertainment expenses, one-time bad debt write-offs, etc.
4. Normalize Benefits and Compensation. This is likely the hardest step and may require a little research or talking to industry peers. Identify normal or average compensation for the management position needed to replace you for similar companies and compare to your own salary and benefits. If there is a difference between current compensation in the company and the market, you can add back in the difference to arrive at your final number.
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