EBITDA

Josh Aharonoff Chris Reilly

CFO for Startups | Founder & Expert Financial Modeler
CEO at Mighty Digits and Solopreneur

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About
this guide

In this guide

In this guide you'll learn all

about EBITDA, why it's so
popular, and common
misunderstandings

Josh Aharonoff & Chris Reilly

EBITDA 2
Contents

1 What is EBITDA? 4

2 How do you calculate EBITDA? 6

3 Why is EBITDA important? 8

4 Common Misunderstandings with 13

EBITDA

5 Other Forms of EBITDA 18

Josh Aharonoff & Chris Reilly

EBITDA 3
 What is
EBITDA?
1

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EBITDA
literally stands for

E EARNINGS

B BEFORE

I INTEREST

T TAXES

D DEPRECIATION

A AMORTIZATION

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EBITDA - What is EBITDA? 5

 How is EBITDA
Calculated?

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 As the name implies…

Start with your EARNINGS

Net income

Then add back your INTEREST expense

and subtract out your interest income

Add back back your TAXES

note this is your income tax, not other taxes like
payroll tax, or franchise tax

Add back your DEPRECIATION

Add back your AMORTIZATION

Net Income

Interest Expense

Interest Income

Taxes

n & Amortization
Depreciatio
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 Why is EBITDA
So Important?

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 1

EBITDA is
commonly used
in valuations

8x
EBITDA

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EBITDA - Why is EBITDA So Important? 9

 2

EBITDA is one of several metrics

that can be used to help value a
business. It is often used as an
approximation for cash flow
because it provides a normalized
measure of a company's financial
performance that is not affected by
changes in the tax code or
differences in accounting practices.

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EBITDA - Why is EBITDA So Important? 10

 2

EBITDA is often multiplied by a

"market multiple" (such as 8.0x)
to arrive at a business valuation.
This "market multiple" can be
obtained by looking at previous
transactions of comparable
companies in the same industry
to see what the company is
"trading for".

However, although EBITDA is commonly

used as an approximation for cash flow,
it can be a misleading figure as it
excludes capital expenditures, changes in
working capital, and equity distributions.

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EBITDA - Why is EBITDA So Important? 11

EBITDA is also 3

commonly referenced
on a number of ratios

EBITDA TO SALES / EBITDA MARGIN

NET DEBT TO EBITDA

EV TO EBITDA

FIXED CHARGE COVERAGE RATIO

LEVERAGE RATIO

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EBITDA - Why is EBITDA So Important? 12

 Common
Misunderstandings
with EBITDA

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 1

EBITDA is not a GAAP

metric
EBITDA GAAP

Therefore the adjustments are discretionary

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EBITDA - Common Misunderstandings with EBITDA 14

 2

EBITDA does
not equal cash
flow

It is often used as an approximation for

cash flow because it provides a normalized
measure of a company's financial
performance, but it does not equal cash

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EBITDA - Common Misunderstandings with EBITDA 15

 3

EBITDA is not the

same as net
operating income

Net Operating Income = Gross Profit -

Operating Expenses. For some companies,
depreciation / interest may be already
included in this formula, as opposed to in
“other income” or “other expense”

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EBITDA Does not
4

show the QUALITY of

your earnings

Not all earnings are created equal

Recurring revenue is often times

more valuable than one-time
revenue

Services Revenue
Good

Annual Recurring Revenue

Much Better

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 Other Forms of EBITDA

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So far, we have been
referencing "EBITDA, As
Defined" aka the literal
definition

But from there it can grow into:

Management-Adjusted EBITDA

Diligence-Adjusted EBITDA

Lender-Adjusted EBITDA

Pro-Forma Adjusted EBITDA

And the adjustments typically get

more discretionary as you go.

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Management-Adjusted
EBITDA

Includes discretionary adjustments

(commonly called "add-backs") from
the Management team to help
normalize the financial performance.
These "add-backs" should be non-
recurring in nature, such as a one-
time cost related to a Consultant.
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Diligence-Adjusted
EBITDA

As part of a potential acquisition, the

acquirer has a chance to scrutinize
and challenge the Management
Adjustments
For example, they could say, "we know you added-
back the cost of the Consultant, but without them you
wouldn't be able to get the work done and would have
to hire someone full-time, so we can't give you "add-
back credit" for that expense

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Lender-Adjusted
EBITDA

After diligence, sometimes

the Lender will (or won't)
allow specific adjustments
such as a private equity
management fee

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Pro-Forma Adjusted
EBITDA

When looking on a TTM basis, it's

common to include "run-rate
adjustments" for new initiatives such
as a new store or location. The idea is
that the lender will give you "credit"
for your covenants even though the
initiative is brand new

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The whole idea here is that
Adjusted EBITDA is trying to
normalize operations (as a
proxy for cash) on which to
base a valuation

Since a valua tio n m ig ht b e

8x, that m e a n s e v e r y
EBITDA ad ju s t m e n t is
"worth" $8 .0 0 . Th at 's w hy
it's so im po rt a n t t o
a d ju s t m en ts.
scrutinize the

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All the different "tiers" of
Adjusted EBITDA from above
are often compiled in a
schedule called a Quality of
Earnings Report or "QofE"
prepared by an outside
accounting firm

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As you can see, the QofE schedule
clearly maps out each "tier" of Adjusted
EBITDA so everyone can be on the
same page as to what the "normalized
earnings" are and can agree or
challenge accordingly.

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Thanks For
Reading!
Did you enjoy this content?
Do you have anything to add?
Questions?

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 Author

Chris
Reilly
I've helped middle-market PE companies for nearly
a decade and built my fair share of Adjusted
EBITDA schedules into complex financial models.

EBITDA certainly has its flaws, but in the later-stage

PE world it commonly serves as a basis for business
valuation.

Today, I teach Finance Professionals to build these

models without all the frustration and confusion
that I experienced on the job.

Follow me at

linkedin.com/in/chris-reilly-mission-capital

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EBITDA 28
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Follow me at

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