🟢 First, what is EBITDA?

An 𝘼𝙋𝙋𝙍𝙊𝙓𝙄𝙈𝘼𝙏𝙄𝙊𝙉 of the free cash flow of a business.

🟢 What's EBITDA (mostly) used for?

A basis for valuation.

🟢 What's EBITDA missing?

Capital Expenditures or "Capex."

Btw, "Capex" is cash spent on assets.

Things like buildings, vehicles, & equipment.

But, "Capex" is 𝙉𝙊𝙏 reflected in the Income Statement.

(it shows up in the Statement of Cash Flows)

🟢 If I were to remember just 𝙊𝙉𝙀 𝙏𝙃𝙄𝙉𝙂:

EBITDA is 𝙉𝙊𝙏 part of GAAP.

Meaning its calculation is subjective.

And the subjectivity can have several "tiers" or "layers."

🟢 Let's build it:

🔵 First, "EBITDA, As Defined"

Meaning: Earnings 𝘽𝙀𝙁𝙊𝙍𝙀 Interest, Taxes, Depreciation, & Amortization.

𝗡𝗢𝗧𝗘: all the (+/-) below are called "add-backs"

Okay let's go...

= Net Income

(+) Interest Expense

(-) Interest Income

(+) Taxes

(+) Depreciation & Amortization

= EBITDA, As Defined

🔵 Next, "EBITDA, Management Adjusted"

Meaning: "EBITDA, As Defined" 𝙋𝙇𝙐𝙎 Management's 𝙊𝙋𝙄𝙉𝙄𝙊𝙉 of non-recurring items.

= EBITDA, As Defined

(+) [Non-recurring Expense] — like hiring a consultant

(+) [Non-recurring Expense] — like unexpected legal fees

(-) [Non-recurring Income] — like receiving a PPP loan

(+/-) Other Non-recurring items

= EBITDA, Management Adjusted

(remember, EBITDA is 𝙉𝙊𝙏 part of GAAP, so these "add-backs" are 𝙊𝙋𝙄𝙉𝙄𝙊𝙉𝙎)

🔵 Next, "EBITDA, Diligence Adjusted"

Meaning: "EBITDA, Management Adjusted" 𝙋𝙇𝙐𝙎 expenses related to an acquisition.

= EBITDA, Management Adjusted

(+) [Acquisition cost] — like legal fees to write the Purchase Agreement

(+) [Acquisition cost] — like Accounting Fees to verify the financials

(+) [Acquisition cost] — like success fees to a Private Equity firm for closing the deal

(+/-) Other items determined during diligence

= EBITDA, Diligence Adjusted

🔵 Next, "EBITDA, PE Firm Adjusted"

Meaning: "EBITDA, Diligence Adjusted" 𝙋𝙇𝙐𝙎 Private Equity firm expenses.

= EBITDA, Diligence Adjusted

(+) Private Equity Management Fee

(+/-) Other items related to a Private Equity owner

= 𝗘𝗕𝗜𝗧𝗗𝗔, 𝗣𝗘 𝗙𝗶𝗿𝗺 𝗔𝗱𝗷𝘂𝘀𝘁𝗲𝗱

Wait, why can they do this?

Remember, the PE firm won't be the owners forever.

So, they will "add-back" their costs so long as they own the business.
We made it.

🟢 What's the goal here?

To get a sense of the 𝙉𝙊𝙍𝙈𝘼𝙇𝙄𝙕𝙀𝘿 free cash flow of the business.

🟢 Why?

Valuation.

EBITDA is multiplied by a "market multiple" (i.e. 8x) to value the business.

So, $1mm EBITDA x 8x = $8mm valuation.

Which means, every $1 add-back is "worth" $8.

So, each add-back can drastically change valuation.

And this is why EBITDA is so heavily scrutinized.

🟢 B/c we are trying to make the valuation 𝙁𝘼𝙄𝙍 & 𝘼𝘾𝘾𝙐𝙍𝘼𝙏𝙀.

—Chris