Pros and Cons of Adjusted EBITDA in Valuations

To create a credible business appraisal you need to choose the appropriate earnings basis. Many professionals use Adjusted EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization) for this. And like any other choice it has its pros and cons.

Pros

Isn’t using the accounting EBITDA measure of income enough? Many business brokers feel that EBITDA should be adjusted further.

Normalization of Earnings and Expenses

You may opt to use adjusted EBITDA  in order to adjust or normalize business expenses. Let’s say you decide to remove non-recurring or discretionary expenses that obscure the company’s true financial track record.  Then you should consider such common line items as the owner’s salary above or below the market, one-time moving expenses or unexpected legal fees.

Comparability

Adjusted EBITDA helps you zero in on operational earnings so that you can  compare your firm to similar companies, especially within the same industry.

Flexibility

Unlike strict accounting earnings bases, Adjusted EBITDA offers flexibility in adjusting for items that may distort the firm’s actual financial performance. This adaptability can be really useful when dealing with young or rapidly growing companies.

Cons

Lack of Standardization

The fact that there are many definitions of what adjusted EBITDA is presents a challenge. Adjustments made to EBITDA can vary quite a bit depending on who makes them. And this leads to inconsistencies and potential misinterpretations.

Open Interpretation

Adjusted EBITDA definition is not black and white. There are no clear guidelines on how to figure it out. So it is possible for an appraiser to make overly aggressive adjustments to portray a more favorable financial picture than the company’s facts warrant.

Limited Insight

If your adjusted EBITDA fails to reveal the company’s actual earning power, take heart. Consider alternatives like Net Cash Flow or Seller’s Discretionary Earnings.

True, adjusted EBITDA gives you a valuable tool in business valuation. But it is important to recognize its limitations such as the lack of standardization. When in doubt consider using adjusted EBITDA alongside other well-defined measures of earnings, such as Net Cash Flow and Seller’s Discretionary Earnings.

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