EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization) is a commonly used financial metric that offers a snapshot of a company’s operational performance.
However, EBITDA can be limited by excluding certain adjustments that might give a fuller picture of a company’s financial health.
Adjusted EBITDA comes in—it refines the EBITDA metric by adjusting for non-operational, non-cash, or one-time expenses.
These adjustments allow business owners, investors, and analysts to evaluate core operational profitability accurately.
This post will explore common EBITDA adjustments companies make and explain how these adjustments impact financial reporting, business valuations, and strategic decisions.
For a deeper understanding of Adjusted EBITDA and how to calculate it, check out our detailed blog on Adjusted EBITDA.
Why Adjust EBITDA?
While EBITDA is useful for measuring profitability, it doesn’t account for non-operating costs or one-off items that may not reflect a business’s ongoing performance.
Adjusting EBITDA helps to remove these outliers, making the resulting figure a more reliable indicator of a company’s core operational earnings.
For example, a company may experience a one-time legal expense or make significant restructuring efforts.
Adjusting for these non-recurring costs gives you a clearer picture of how the business performs in its normal operations, free from the distortion of extraordinary items.
Learn more about the importance of accurate financial metrics by reading our guide on financial analysis for retirement.
Common EBITDA Adjustments
Non-Operating Income and Expenses
- What It Means: Non-operating income or expenses come from activities not part of the core business. This could include investment income, gains or losses from the sale of assets, or one-time gains.
- Adjustment Example: A company sells equipment for a one-time profit. Since this gain is not part of the company’s normal operations, an adjustment would exclude it from EBITDA.
Understanding these one-time gains and losses is critical for ongoing strategic planning. Learn more about effective strategic planning for entrepreneurs and how these financial adjustments fit into the bigger picture.
One-Time Gains or Losses
- What It Means: Sometimes businesses face significant one-off gains or losses that don’t regularly occur. This could be due to a lawsuit, natural disaster, or a one-time business transaction.
- Adjustment Example: If a company wins a legal settlement or faces a lawsuit expense, this would be adjusted out of EBITDA to provide a clearer view of ongoing operational profitability.
- Related Reading: Learn more about how one-time expenses impact Adjusted EBITDA.
Stock-Based Compensation
- What It Means: Some companies pay executives or key employees with stock options instead of cash. This non-cash expense doesn’t affect the company’s cash flow, but it is still accounted for in the financials.
- Adjustment Example: Companies often adjust EBITDA by adding back stock-based compensation to indicate the business’s actual cash flow better.
Compensating employees with stock options is common for businesses scaling with tech-driven operations or those in high-growth phases.
If you’re strategizing growth, explore our KPI Strategic Planning blog post.
Restructuring Costs
- What It Means: Restructuring costs occur when a company reorganizes its operations, perhaps due to downsizing, merging, or closing divisions. These costs are generally not part of ongoing operations and should be adjusted.
- Adjustment Example: A company undergoing restructuring might incur high severance costs. This would be adjusted out of EBITDA to avoid distorting the company’s operational performance.
Learn how companies in transition can benefit from business growth planning software, enabling them to navigate restructuring efficiently while maintaining profitability.
Litigation Expenses
- What It Means: Legal battles can result in substantial costs not part of the regular course of business. Adjusting for litigation costs provides a clearer view of core operational earnings.
- Adjustment Example: If a company faces a one-time legal settlement, this would be added back to EBITDA as it does not reflect the business’s ongoing performance.
Litigation costs can heavily influence financial metrics. Companies in specialized sectors like exit planning should also be aware of how such adjustments affect long-term profitability.
How These Adjustments Affect Your Business Valuation
Making EBITDA adjustments allows a clearer view of your company’s operational efficiency. For example, a company undergoing significant restructuring may seem less profitable if restructuring costs are included in the EBITDA calculation. By making adjustments, you reveal the company’s true operational health, making it more attractive to potential investors or buyers.
For business owners looking to attract financing or investors, presenting Adjusted EBITDA is essential as it more accurately reflects the company’s ability to generate cash flow from its core operations.
Final Thoughts: Use Adjusted EBITDA to Understand Core Profitability
Adjusted EBITDA is a powerful tool for business owners, investors, and financial analysts. It removes the noise of non-operational and one-off events, providing a clearer picture of a company’s operational success.
Understanding the common adjustments made to EBITDA is key to getting an accurate picture of a company’s performance. Whether evaluating your own business or assessing a potential investment, Adjusted EBITDA can help guide more informed decisions.
For a complete guide to understanding Adjusted EBITDA and its formula, visit our blog post here.