Learn how to properly adjust EBITDA for business valuation with expert guidance on normalization techniques, acceptable adjustments, and documentation requirements
Calculate Your Adjusted EBITDAIs your company's standard income statement telling the whole story? For most businesses, it isn't. One-time expenses or unusual events can obscure a company's true earning power. That's where Adjusted EBITDA comes in. It's a crucial metric designed to show a potential buyer the real, sustainable cash flow your business generates.
Adjusted EBITDA (also called Normalized EBITDA) is the base EBITDA calculation with additional adjustments to remove non-recurring, unusual, or non-business expenses to show the true operating performance of a business. Understanding the difference between EBITDA and SDE is crucial before making adjustments.
Adjusting for documented, one-time costs that are not part of normal operations:
Normalizing owner compensation to a fair market rate and adding back verified personal expenses paid for by the business:
Personal expenses inappropriately run through the business:
Non-cash expenses that reduce reported income:
Adjustments to reflect market conditions or normalize operations:
Adjustments for recent business model or operational changes:
Every adjustment, whether adding back an expense or normalizing revenue, must be rigorously documented and defensible. An unsubstantiated adjustment is worthless under scrutiny from the IRS, a buyer's due diligence team, or in court.
A credible valuation hinges on the quality and proof of its adjustments. This means maintaining detailed records, supporting documents, and clear explanations for every normalization made.
Start with net income and add back interest, taxes, depreciation, and amortization to establish your base EBITDA figure.
Review financial statements for the past 3-5 years to identify potential adjustments. Look for unusual, non-recurring, or personal items.
Pro Tip: Review each expense category line-by-line and ask "Would a new owner incur this expense in normal operations?"
Each adjustment must be reasonable, well-documented, and pass the "would a buyer accept this?" test. Conservative adjustments are more defensible.
Maintain detailed documentation for every adjustment including supporting documents, explanations, and calculations. This is critical for credibility.
Add all validated adjustments to your base EBITDA to arrive at your final adjusted EBITDA figure for valuation purposes.
33% increase over base EBITDA ($290,000)
Adding back legitimate business expenses that a new owner would incur.
Failing to maintain supporting documentation for adjustments.
Applying adjustments inconsistently across different time periods.
Not considering what adjustments buyers will accept.
Making adjustments for expenses that haven't actually been incurred.
When in doubt, don't adjust. Conservative adjustments are more credible. Learn about common valuation mistakes to avoid over-adjusting.
Keep detailed records and supporting documents for every adjustment.
Base compensation adjustments on market data for similar roles.
Have adjustments reviewed by a valuation professional.
Use 3-5 year average adjusted EBITDA for more stable valuations.
There's no hard rule, but adjustments typically range from 10-30% of base EBITDA for most small businesses. Larger adjustments require exceptional documentation and justification. Focus on quality and defensibility over quantity.
Yes, but carefully. Add back extraordinary COVID expenses (PPP loan costs, one-time safety equipment) but be cautious about operational changes that may be permanent. Consider both positive and negative COVID impacts for fairness.
No. Adjusted EBITDA should reflect historical performance normalized for one-time items, not future potential. Synergies and improvements are considered separately in valuation analysis and may justify premium pricing.
Research market salaries for similar positions in your industry and geography. Adjust to market rate, not to zero. Document your research with salary surveys or job postings. Remember that buyers need to budget for replacement management.
Understand the key differences between EBITDA and Seller's Discretionary Earnings.
Learn MoreLearn how valuation multiples are applied to adjusted EBITDA for business valuations.
Learn MoreExplore comprehensive business valuation methods and when to use each approach.
Learn MoreGet professional guidance on normalizing your EBITDA for accurate business valuation. Our CVA can help identify valid adjustments and ensure proper documentation.