EBITDA stands for Earnings Before Interest, Taxes, Depreciation, and Amortization. It represents a company's operating performance by focusing on earnings from core business operations, excluding the effects of capital structure, tax rates, and non-cash accounting items.

Why is EBITDA Important?

EBITDA is a crucial metric because it is often used to value a company.

Businesses are typically sold based on a multiple of their EBITDA. For example, a company with an EBITDA of $3,000,000 and an 8x multiple would be valued at $24,000,000.

Understanding Adjustments to EBITDA

While some adjustments to EBITDA, such as adding back interest and depreciation, are straightforward, other cash adjustments can be more complex. Here are a few examples to illustrate:

• Owner's Compensation Adjustment: If you take a salary of $500,000, but the market salary for a general manager is $150,000, you would add back the difference of $350,000 (plus related payroll taxes) to EBITDA.
• Family Member Salaries: If your wife and daughter each receive a salary of $75,000 but do minimal work, you would add back $150,000 (plus related payroll taxes) to EBITDA.
• Pension Contributions: If you had a banner year and made a pension contribution of $1,000,000, but the typical contribution is $500,000, you would add back the excess $500,000.
• Inventory Write-offs and Selling Expenses: Any inventory write-offs used to reduce taxes should be added back, as should any expenses incurred in the process of selling the company.

Challenges in Adjusting EBITDA

Identifying and adjusting EBITDA for these cash adjustments can be straightforward for an experienced professional. However, supporting and defending these adjustments to ensure they are accepted can be challenging. Buyers and their financial advisors, such as CPAs and CFOs, will scrutinize these adjustments and may reduce the purchase price if they can justify a cut.

Therefore, it's essential to meticulously document and support every adjustment to present a credible and defensible EBITDA figure.