Adjusted EBITDA

This measure is particularly beneficial when used to estimate a company's value for activities like mergers, acquisitions, or capital raising.

Sid Arora

Reviewed by

Sid Arora

Expertise: Investment Banking | Hedge Fund | Private Equity


July 3, 2023

Earnings Before Interest, Taxes, Depreciation, and Amortization, or EBITDA, is a useful indicator of the company's operating performance.

It allows for assessing productivity, efficiency, and return on capital without considering the effects of interest costs, tax expenses, asset base, and other operating costs.

Analysts and experts use EBITDA to compare businesses within and outside the same industry.

EBITDA measures a company's ability to generate cash before considering the weight of capital assets, taxes, and debt. It is the most commonly used and comparable metric of cash flow.

Since EBITDA is unaffected by such factors, it may help compare organizations with various levels of debt, capital assets, or even tax rates with one another.

Key Takeaways:
  • EBITDA is a useful indicator of a company's operating performance.
  • It allows for comparing businesses within and outside the same industry.
  • Normalizing EBITDA involves removing irregular expenses to show potential future earnings.
  • Adjusted EBITDA eliminates one-time expenses for a comparable evaluation.
  • Adjustments may include owner compensation, related-party transactions, and inventory valuations.

The relevance and meaning of normalizing EBITDA

Normalizing EBITDA involves removing extraordinary, non-recurring, non-core, irregular revenue that, after corrections, represents the potential future earnings that a buyer may anticipate from the company.

Since normalized or adjusted EBITDA (AE) eliminates deviations and anomalies and regularizes historical streams of cash flows, it is a useful valuation tool during the acquisition of a corporation.

The most recent trailing 12 months of financial statements should be used to calculate EBITDA. The buyer and seller must add several normalizing adjustments to the EBITDA to get AE.

The AE shows the buyer's expected future earnings and may include some non-recurring expenses that were deducted from the income statement but were later canceled and needed to be brought back to the EBITDA.

The buyer should estimate any negative revisions to historical EBITDA, which may take the form of additional expense items after the acquisition and lower future EBITDA, in addition to determining the business's fundamental earning capacity.

Multiple of the company's normalized EBITDA is a simple and effective way to evaluate a company, among other widely used valuation techniques (i.e., 6x TTM EBITDA).

The sellers and their hired investment bankers are motivated to achieve a higher EBITDA because it would result in a higher business valuation by the EBITDA Multiple methods.

Typically, normalizing EBITDA leads to higher post-acquisition EBITDA by adding back non-recurring and extraordinary expenses.

Instead, buyers are cautious to avoid paying for business value that might not be realized in the future and ensure that such normalization adjustments do not result in an overstated EBITDA.


The buyer spends a lot of time examining the normalization adjustments made by the seller and checking the books of accounts and projected financials for non-recurring income that could lower EBITDA and, consequently, the transaction price.

Calculating Adjusted EBITDA

To compute adjusted or normalized EBITDA, irregular, one-time, or nonrecurring items are subtracted from the total to provide a comparable number.

Knowing how to calculate adjusted EBITDA can be helpful if you work as a financial analyst or another financial professional.

Standard EBITDA = Earnings + Interest + Taxes + Depreciation and Amortisation

Normalised EBITDA = Standard EBITDA +/- Adjustments

The following are a few situations where normalizing EBITDA becomes essential:

  • Income, revenue, or expense that are one-time-only and not anticipated to be repeated annually.
  • Amounts of income, expense, revenue, or capital assets not valued in the financial statements at fair market value.
  • Excessively aggressive or conservative accounting policies or estimates.

Here are a few modifications that small- to medium-sized businesses make most frequently, categorized as nonrecurring and non-core revenues and expenses.


These modifications to EBITDA might vary significantly by sector, business, period, and individual circumstances.

Example of Adjusted EBITDA

To arrive at adjusted EBITDA, adjustments, including restructuring, legal fees, and one-time expenses, are added to or subtracted from the standard EBITDA.

Adjusted EBITDA is calculated to produce a number unaffected by irregular, one-time, or nonrecurring expenses.

Due to this, it may be simpler to compare businesses operating in the same sector, making adjusted EBITDA one of the key criteria that prospective purchasers consider.

Following are a few examples of adjustments required to be added or subtracted to arrive at Adjusted EBITDA:

1. Related parties and owner’s compensation and remuneration

Having authority over the amount of compensation to be paid to oneself, business owners, typically of private limited businesses, frequently pay themselves a higher or lower income than independent third-party management.

As a result, their compensation may not be marked to market. It may exhibit owner bias since they may offer a greater salary as a tax avoidance measure in a particular, fiscal year or a lower salary than fair market value to report a larger net income for that fiscal year.

Additionally, to reduce the company's income tax, the owner may declare unusual incentives to the managerial staff at the end of the year.

The historical EBITDA may be adjusted to reflect specific owner-related business and personal expenses deducted from the income statement but may not have occurred following the business acquisition transaction.

These costs include

  • Personal automobiles
  • Health
  • Life
  • Auto
  • Keyman Insurance
  • Excessively high travel and lodging costs
  • Entertainment costs
  • Club and association dues

To reach the recurring EBITDA, higher salaries and other compensation provided to specific family members who may not be actively involved in the business operations may be added back.

Also, the salary of third-party management at fair market value or a market-based price may be deducted.


When the prospective buyer anticipates a replacement for the owner who may need equivalent services, perquisites, or other similar benefits, owner-related expenses may not be reduced in such situations.

2. Income or Expenses Not at Arm's Length

Such revenue or expenses result from related-party transactions between the business entity and its related parties at a higher or lower price than market rates.

And the historical EBITDA must be modified to eliminate such revenues or expenses and consider the ones at arm's-length pricing and are between two unrelated and independent parties.

A few instances of income or expenses not at arm's length include the following:

  • Related entities selling products or services to one another at inflated prices and/or
  • Cross-utilization of employees at no or insufficient compensation is not in line with the market rates of similar labor input.

If the company being valued is a subsidiary of a holding company, most of its sales are made to that holding company at non-arm's length pricing.

Suppose the company under valuation buys supplies from a supplier company where a director of the former company is involved or a major shareholder. In that case, the purchases are made at a price higher than the market value.

Then, the valuer is required to normalize the EBITDA by eliminating the effect of such understated profit due to inflated purchases from a related party and ensuring that EBITDA reflects the fair market value of these supplies when the supplies are purchased.

The benefits of some rebates or discounts might not transfer to a new owner; these transactions might be categorized as not being conducted at arm's length. Therefore, the valuer should consider these sums while decreasing past EBITDA.

The transaction may not be considered marked-to-market if there is synergistic value because of the nature of the transaction itself.

For instance, certain purchase transactions between a retail-based pharmaceuticals company and a research-based pharmaceuticals company may create synergistic value but not be deemed at market price.

In this case, the valuer may have to consider normalizing the EBITDA if one of the companies.

3. Expenses or income produced by redundant assets

Expenses incurred on redundant or non-productive assets, or assets owned by the company that doesn't contribute to revenue-generating activities or the running of the business, may be added back to the historical EBITDA.

Historical EBITDA is reduced from the income from redundant or non-productive assets, i.e., assets possessed by the company that doesn't contribute to revenue-generating activities or towards the management of the business.

Say, for instance, a guest house is kept for the use and welfare of corporate employees, and use was made available as a reward for the employees' good work, or the guest house was extensively used during COVID times.

Maintenance costs for the guest home may be brought back to normalize the EBITDA since they are not directly related to the firm's functioning.

For instance, if a company operates four manufacturing facilities, one is rendered redundant or non-operational for any reason. Expenses incurred for maintaining the redundant facility may be added back to the EBITDA.

It is added back to EBITDA because no corresponding revenue from such a facility can be estimated.

4. Rentals at rates above or below fair market value

The company under appraisal may already be a tenant under a lease or rental agreement with the seller.

In this case, the company may be paying rent above or below market rates, and relevant changes must be made in the historical EBITDA to reflect the fair market rent level.

For instance, if the owner-director of a company or the shareholder-director of its holding company rents out an office building, the rent is higher than the market rent for properties in the same location.

If this is the case, upward EBITDA adjustments may be necessary by adding back the arbitrary and non-length arm's rent and lowering the true market rent.

For instance, Public Sector Undertakings (PSUs) frequently have offices at rent levels significantly lower than comparable commercial buildings in the same area.

As a result, the EBITDA can be adjusted by taking the market rent away and bringing the actual lower rent back in. The valuer may also need to check these rental or lease agreements for expiration dates and other restrictions.

If a business entity owns unnecessary real estate, does not support the business's core operations, or is not essential to those operations, the buyer does not intend to use the property.

The related costs like insurance, maintenance, property tax, and any rental income must be subtracted from the historical EBITDA.

5. One-Time Disputes, Lawsuits, Recoveries from Insurance Claims, and Arbitrations

It would be appropriate to add back these costs to the historical EBITDA if the corporation is involved in a one-time or extraordinarily expensive and unusual lawsuit that won't happen again.


It is important to remember that ongoing recurring legal costs and costs for which a provision has been made will not be returned to EBITDA.

For instance, it might not be viewed as a one-time event to regularly make provisions for the predicted credit loss on trade receivables.

However, to normalize EBITDA, it may be necessary to add back or deduct, as appropriate.

In addition, any extraordinary income or expenses in the form of lawsuits, arbitrations, insurance claim recoveries, and one-time disputes that may have been resolved during the review period and may not recur needs to be adjusted.

For example, in the event of an insurance recovery on the death of the managing director, under the terms of a Keyman Insurance policy would be subtracted from EBITDA to normalize it for the company.


An insurance claim recovery on the loss of stocks due to a cyclone or an insurance recovery on the demolition of immovable property due to any natural calamity will be adjusted.

6. Inventory Valuations

When lockdowns were lifted, the demand for some FMCG products normalized, and the suppliers maintained multiple times the volume of stock to keep up with the surge in demand.

As a result, these suppliers ended up with a high volume of closing stock piling up after the demand for these products normalized after the lockdowns.

Therefore, stock normalization may be necessary if uncontrollable circumstances bring on non-recurring occurrences of such unanticipated stock movement.

In addition, in some circumstances, due to the inventory's inherent characteristics, the inventory's value may significantly increase or decrease, which may impact the business's valuation.

For example, in the case of jewelry, gold, and other precious metals and stones inventory for jewelers, the valuer may be required to consider future forecasted prices of such precious metals during the forecasted period and may consider the same to ensure relevance in computing the normalized EBITDA.

If the company needs equipment to deliver services, this will also necessitate the year-round procurement of parts and components.

An estimated general allowance often covers the cost of these parts and components. However, if the value of these items exceeds the allowance, it may be prudent to value this inventory close to the date of selling the business.

Additionally, any extra value of items above and beyond the general allowance may be added back to normalize EBITDA.

For example, the management should determine the market worth of slow-moving or obsolete goods that must be written off or sold for scrap.

By removing such types of stock from the closing balance of inventory, the valuer should assure normalization in inventory and prevent any impact on the business valuation.

7. One-off professional fees

There might be one-time professional fees associated with establishing a new service vertical, business unit, or branch and additional costs unique to the new service.

Costs, such as research and development, marketing, training, and other setups, need to be added back to normalize EBITDA.

Regular legal expenses, which are necessary for business operations and for which a provision may have already been made, would not be added back to EBITDA because they are inherent to the business and will be anticipated to continue.

When a buyout transaction is completed, the buyer's current support infrastructure, such as the engineering staff, accounting department, legal staff, human resources department, or other professional departments, will continue to operate.

And such professional third-party expenses for similar services would no longer be necessary to be incurred. As a result, such expenses will be added back to the historical EBITDA.


Professional services may be needed once for creating family trusts, entity reorganizations, or insurance claims; since these costs are one-time, they should be added back to or deducted from the historical EBITDA as appropriate.

8. One-off set-up costs

Start-up/Set-up costs and associated costs are one-time expenses that are no longer incurred. However, if they were incurred with introducing a new business vertical within the same period, they should be added back to the historical EBITDA.

For example, consider the valuation of DoorDash, whose primary business model is food delivery, and launched a new service vertical for groceries delivery under the name Dashmart.

The set-up costs and related charges for the new vertical may be added back to the historical EBITDA for its normalization when considering DoorDash’s past performance, provided that introducing new service verticals is not frequent.

9. Management Gaps

If the company is predominantly driven by its owners or after the buyer has acquired it, key managerial employees may leave it. The buyer may need to hire fresh talent to cover the holes in the top line and the functional management level.

The compensation, benefits, and other expenses associated with the recruits would probably result in a negative revision to EBITDA.

The buyer may also decide that a simple bookkeeper needs to be replaced by a more senior financial executive, a virtual CFO, a financial controller, or a chartered accountant due to the organization's expanding needs.

This additional compensation could harm the organization's historical EBITDA.

10. Other One-off Income and Expenses

This category may classify unusual discretionary revenue or expenses, such as record-breaking one-time employee bonuses or unique contribution expenses, which should be added back to EBITDA to normalize.

Suppose there have been excessive or insufficient repair and maintenance costs in some years. Then, a forecast of a suitable amount of repair and maintenance costs should be prepared considering the age and condition of the fixed assets.

In other instances, business owners might have aggressively deducted the cost of capital assets rather than capitalizing them and claiming depreciation expense over time on the balance sheet.

The valuer should ensure that the seller's accounting practices haven't a detrimental effect on past EBITDA.


The valuer should consider and be aware of other extraordinary items.

Extraordinary items include

  • changes in the amount of upcoming insurance (positive or negative),
  • impending wage rate increase (negative),
  • fire, cyclone, or other natural disasters that have resulted in one-time expenses for repair or reconstruction.
  • One-time major building renovation or repair costs,
  • non-GAAP,
  • unusual accounting practices adopted by the seller, and more (negative).

The valuer should be vigilant and look for other non-recurring and one-time expenses.

  • loss from fraud,
  • mismanagement,
  • theft or siphoning off funds,
  • loss from labor strikes or lockouts,
  • unusually high gain or loss from asset sales,
  • one-time office moving costs,
  • CEO recruitment fees,
  • severance costs,
  • goodwill impairment, and
  • unusual gain.


The adjusted EBITDA measure is particularly beneficial when estimating a company's value for mergers, acquisitions, or capital raising.

The value of a corporation, for instance, could fluctuate dramatically following add-backs if it is evaluated using a multiple of EBITDA.

Assuming a firm is being appraised for a sale transaction, the estimated purchase price was determined using an EBITDA multiple of 6x.

The company's purchase price would increase by $6 million ($1 million multiplied by the 6x multiple) if the company had just $1 million in non-recurring or unusual expenses to add back as EBITDA adjustments.

Because of this, stock analysts and investment bankers pay close attention to EBITDA changes during these kinds of deals.

The goal is the same, but how a company adjusts its EBITDA might differ significantly from one company to the next.

By "normalizing" the EBITDA statistic, the goal is to make the number generic and ensure that it reflects the line-item costs that any comparable company in its industry would have.

Various expenses added back to EBITDA often make up the most changes. Because expenses were lowered, the resulting AE frequently shows greater earnings levels.


The data is frequently smoothed out by analysts using a three- or five-year average AE.

The ideal AE margin is greater. However, due to variations in their methodology and underlying assumptions, different companies or analysts may arrive at slightly different AE figures.

While non-normalized EBITDA is frequently disclosed to the public, AE is not.

It is significant to highlight that AE is not a line item on a company's income statement that conforms to generally accepted accounting principles (GAAP). Hence, analysts spend a fair amount of time arriving at adjusted EBITDA.

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Researched and authored by Frank Pereira | LinkedIn

Reviewed and edited by Parul GuptaLinkedIn

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