Understanding EBITDA, Adjusted EBITDA & Cash Flow

By Zoellner Garten & Co.

Earnings Before Interest, Taxes, Depreciation & Amortization (EBITDA) is a common and frequently used measure of the performance of a business. It is pre-tax profit, plus interest, which is a function of capitalization and non-cash items such as depreciation and amortization.

Sellers and seller advisers use it to present a business for sale to buyers, and buyers use it as a guide to determine what they can expect in the future. The sale price of a business is often quoted as a number multiplied by the EBITDA.

Adjusted EBITDA is often used with smaller, typically closely held businesses as a measure of value. The adjustments can and often include compensation of the owner, non-operating, and discretionary expenses. Non-operating expenses might include salaries, cell phones, automobiles, and other expenses paid on behalf of the family of the owner.

EBITDA Rent for the facility used by the business might be adjusted to market the rent higher or lower if the real estate is owned by or has a close relationship with the owner of the business. The adjustments could include many expenses that, in theory, a buyer wouldn’t have to pay.

When a business owner looks at cash flow, they must consider a few things, such as working capital needed to support growth and capital expenditures. They must also ask, “Does the business need to add or upgrade fixed assets or otherwise invest in the business?”

The buyer determines what to do with the Adjusted EBITDA based on their specific needs. For instance, the buyer may need an annual income of about $100,000, which is the use of Adjusted EBITDA. The buyer would most likely have loans to complete the acquisition, in addition to paying the interest and principal to the lender.

See below for an example of Adjusted EBITDA. In this example, it is an asset sale for $2.5 million with buyer equity of $500,000 and a term loan for $2 million. The price is roughly four times the Adjusted EBITDA and is a manufacturer with significant production assets.

Please contact us to discuss your specific business situation.

EXAMPLE

$300,000 Pre-Tax Profit EBITDA

$ 50,000 Interest

$150,000 Depreciation

$500,000 EBITDA

$100,000 Owner Salary

$ 50,000 Owner Discretionary Expenses

$650,000 Total Adjusted EBITDA

The Buyer will utilize Adjusted EBITDA as follows:

$650,000 Total Adjusted EBITDA; LESS

$ 55,000 Taxes on income (1)

$100,000 Year one interest on loans

$200,000 Loan Principal

$ 0 Capital Expenditures: assume none are required in the first two years.

$100,000 Buyer Salary

$455,000 Total EBITDA

$195,000 “Cushion”

NOTE: The “cushion” may seem large, but it’s based in ten year financing. Buyers typically want to pay off the debt sooner, typically within five years.