What is Adjusted EBITDA
Adjusted EBITDA (Earnings Before Interest, Taxes, Depreciation and Amortization) is a measure computed for a company that looks at its "top line" earnings before deducting interest expense, taxes and depreciation charges. It is used to compare related companies and for purposes of valuation. Adjusted EBITDA differs from EBITDA in that adjusted EBITDA normalizes income and expenses since different companies may treat each type of income and expense differently. By standardizing cash flows and discounting anomalies that may occur, adjusted or normalized, EBITDA can provide a useful measure of comparison when evaluating multiple companies.
BREAKING DOWN Adjusted EBITDA
Adjusted EBITDA is defined by the formula:
Net Income - [Total Interest Expense, Income Taxes, Depreciation and Amortization, and Non-Cash Charges for Share-Based Compensation]
Measurement is typically done on an annual basis, but many analysts will look at three-year or five-year average adjusted EBITDA to smooth out the data. The higher the adjusted EBITDA margin, the better. Different firms or analysts may arrive at slightly different adjusted EBITDAs due to differences in their methodology and assumptions. As such, these figures are often not made available to the public, while non-normalized EBITDA is typically public information. It is important to note that adjusted EBITDA is not a Generally Accepted Accounting Principles (GAAP) standard line item on a company's income statement.
Adjusted EBITDA, as opposed to the non-adjusted version, will include normalize income, standardize cash flows, and eliminate abnormalities or idiosyncrasies (such as redundant assets, bonuses paid to owners, rentals above or below fair market value, etc.), often making it easier to compare multiple business units or businesses. Sometimes for smaller firms, owners' personal expenses are run through the business and must be adjusted for. Adjustments for reasonable compensation to owners are defined by Treasury Regulation 1.162-7(b)(3) as “the amount that would ordinarily be paid for like services by like organizations in like circumstances.” Other times, one-time expenses need to be added back, such as legal fees, real estate expenses such as repairs or maintenance, or insurance claims. Non-recurring income and expenses such as one-time startup costs that usually increase EBITDA should also be reconciled in computing the adjusted EBITDA.
Adjusted EBITDA should not be used in isolation and should be part of a suite of analytical tools used to value a company or companies. Ratios that use adjusted EBITDA can also compare companies of different sizes and in different industries, such as the Enterprise Value/Adjusted EBITDA ratio.