Adjusted EBITDA

Adjusted EBITDA is a non‑GAAP measure that starts with EBITDA (earnings before interest, taxes, depreciation, and amortization) and then adds or removes items to produce a “normalized” view of operating earnings. It aims to remove one‑time, unusual, non‑cash, or owner‑specific items so analysts can better compare performance across companies or periods.

Formula

Adjusted EBITDA = Net income + Interest + Taxes + Depreciation + Amortization ± Adjustments

Where adjustments are specific add‑backs or deductions made to remove non‑routine, non‑operational, or one‑time items.

How to calculate (step‑by‑step)

1. Start with net income.
2. Add back interest expense and income tax expense.
3. Add back non‑cash charges: depreciation and amortization.
4. Add or subtract specific adjustments to normalize earnings (see examples below).
5. Optionally, average adjusted EBITDA across several years (commonly 3–5) to smooth volatility.

Common adjustments

Typical items added back or adjusted include:
* Non‑cash expenses (beyond D&A), such as unrealized losses or share‑based compensation
Litigation, restructuring, or other one‑time legal and settlement costs
Owner’s or related‑party compensation above market rates (common in private firms)
One‑off startup, repair, or insurance claim expenses
Gains or losses on foreign exchange and other non‑operating income or expenses
* Goodwill impairments and other unusual write‑downs

What adjusted EBITDA tells you

• Normalizes reported earnings to improve comparability across companies and time periods.
• Helps investors and acquirers estimate recurring operating cash flow and supports valuation multiples (e.g., enterprise value / adjusted EBITDA).
• Useful in M&A, capital raising, and internal performance analysis.

Practical example

If a buyer values a company at a 6× EBITDA multiple and the seller adds back $1 million in non‑recurring expenses to calculate adjusted EBITDA, the implied purchase price increases by $6 million (6 × $1M). That is why adjustments are closely scrutinized in transactions.

Limitations and cautions

• Adjusted EBITDA is not a GAAP metric and can be subjective—companies may report different adjustments.
• It can overstate sustainable earnings if aggressive or recurrent costs are treated as “one‑time.”
• Always use adjusted EBITDA alongside other measures (cash flow, net income, free cash flow, balance sheet metrics) and review the adjustment methodology.

Practical tips

• Require clear disclosure of each adjustment and the rationale.
• Compare like‑for‑like adjustments when benchmarking peers.
• Consider averaging adjusted EBITDA across several periods to reduce the impact of timing and volatile one‑offs.
• Use valuation ratios (e.g., EV / adjusted EBITDA) rather than adjusted EBITDA in isolation.

Sources:
* Code of Federal Regulations, Title 26 §1.162‑7 (Compensation for Personal Services)
* U.S. Securities and Exchange Commission, “Non‑GAAP Financial Measures”