EBITDA calculator

A company with $12 million of revenue and $720,000 of net income has EBITDA of $1,690,000, a 14.1% margin. Its owner presents adjusted EBITDA of $2,110,000. A buyer accepts $1,915,000. At a 6.0 times multiple, the $195,000 gap is $1,170,000 of enterprise value. And none of the three numbers is cash: after taxes, capital spending and working capital, $940,000 of the $1,690,000 reaches the business, and after debt payments $390,000 is left for the owners.

The calculator gets to EBITDA three ways and checks that they agree, tests each add-back from the seller’s side and the buyer’s, carries the result to enterprise and equity value, and then walks it down to cash and debt coverage.

Who reaches for this

You enter the income statement: revenue, cost of goods sold, operating expenses, other income or expense, interest and taxes. You enter depreciation and amortization by where they are recorded, because depreciation is often inside cost of goods sold as well as operating expenses. Then you list the adjustments a seller would claim, each with the share a buyer would accept, and a few cash and debt figures.

The calculator computes EBITDA from net income, from operating income and top-down, so that you can see whether they agree and why they do not. It then computes adjusted EBITDA from both sides of a deal, enterprise and equity value, and a bridge to cash. The business valuation calculator covers valuing smaller owner-run businesses on seller’s discretionary earnings, and the DSCR calculator covers debt coverage from cash flow.

Guides give two or three formulas and call them equivalent. They are, with one condition. The example is an invented company with $12,000,000 of revenue, $7,800,000 of cost of goods sold, $3,100,000 of operating expenses, a $90,000 gain on the sale of equipment, $250,000 of interest and $220,000 of tax. Net income is $720,000. Depreciation is $420,000, of which $300,000 is in cost of goods sold and $120,000 in operating expenses, and amortization is $80,000, so D&A is $500,000.

The first route is $90,000 higher than the other two. That is the gain on the sale of equipment. It sits below operating income and above net income, so starting from net income carries it into EBITDA, and starting from operating income does not. The routes agree only when there is nothing between operating income and pre-tax income except interest.

Which is right? For a public company, the SEC staff says EBITDA presented as a performance measure should be reconciled to net income, which makes the first route the standard one, $1,690,000. For a business being sold, a gain on selling equipment is not part of the ongoing earnings, and it would be deducted as an adjustment, which takes the number back to $1,600,000. The calculator carries the gain as a deduction in the adjustments table for that reason.

Two mistakes account for most wrong EBITDA figures, and one of them is easy to miss on the top-down route.

Depreciation hidden in cost of goods sold

The top-down formula is often written as revenue minus cost of goods sold minus operating expenses excluding depreciation and amortization. It works only if cost of goods sold also excludes depreciation. Manufacturers and other asset-heavy companies record depreciation on production equipment inside cost of goods sold. If you take reported cost of goods sold, and remove D&A only from operating expenses, you leave $300,000 of depreciation in.

In the example that gives $12,000,000 − $7,800,000 − ($3,100,000 − $200,000) = $1,300,000, which is $300,000 below the correct $1,600,000. On a 6.0 times multiple, the error is $1,800,000 of value. The fix is to add back all the depreciation and amortization on the company’s cash flow statement, wherever it was recorded, and the calculator asks for it in three places so that none is missed.

Other income and expense

The second is the $90,000 gap above. Gains and losses on asset sales, litigation awards, foreign exchange gains and investment income sit below operating income. Whether they belong in EBITDA depends on the purpose. A buyer valuing the ongoing business excludes them. A covenant definition may include them, or list them by name. State which you mean, and use the same treatment each period.

EBIT is earnings before interest and taxes, which is net income plus interest and taxes: $720,000 + $250,000 + $220,000 = $1,190,000 in the example. Operating income is $1,100,000, and the $90,000 difference is the same gain. EBITDA is EBIT plus depreciation and amortization. Many people use EBIT and operating income as if they were the same, and they are the same only when there is no other income or expense.

EBITDA is not a GAAP measure, and for public companies the SEC has set out how to present it. The staff’s non-GAAP Compliance and Disclosure Interpretations say that EBIT and EBITDA presented as performance measures should be reconciled to net income and not to operating income, because they adjust for items that are outside operating income. They also say the measures should not be shown per share. A calculation that adjusts for anything beyond interest, taxes, depreciation and amortization should be called adjusted EBITDA. SEC staff comment letters have pressed companies on the first two points.

Those rules bind registrants in their filings and earnings releases. A private sale runs on the purchase agreement and the buyer’s diligence, and a lender’s covenant runs on the credit agreement, each with its own definition of EBITDA. The SEC’s reasoning is still a useful discipline for anyone: start from net income, show every adjustment, and label the result honestly.

Adjusted EBITDA is where most of the argument in a sale happens, because there is no standard list and each adjustment moves the price by the multiple. One guide to deals in the lower middle market says buyers scrutinize 8 to 20 add-backs in a quality-of-earnings review. A useful way to think about them is by how easy each is to support.

The example has six adjustments. Owner pay above market adds $180,000 and a legal settlement adds $95,000. Personal expenses of $45,000 run through the company. Consulting fees of $70,000 are called one-time and have appeared in each of the last three years. A relocation is expected to save $120,000, and it has not happened. A $90,000 gain on the sale of equipment is deducted. Together the seller’s adjustments are +$420,000.

The acceptance shares are illustrations: 100% for the owner pay, the settlement and the gain, 50% for the personal expenses because only part is documented, 25% for the consulting fees because they recur, and 0% for a saving that has not been achieved. In a real process a buyer’s advisers decide each, from documents.

Stock-based pay, leases and other judgment calls

Some adjustments have no settled treatment. Stock-based compensation is a real cost paid in equity, and many companies add it back while critics say it should stay in as an expense. Rent is another: for lease-heavy businesses some analysts use EBITDAR, which adds back rent, so that companies that lease and companies that own can be compared. A seller who uses either should say so, and a buyer who is shown an EBITDA should ask which conventions it follows before comparing it with another.

Each adjustment is worth the multiple times its amount, so the acceptance decisions turn directly into dollars. At 6.0 times, the seller’s view and the buyer’s differ as follows.

Reported EBITDA of $1,690,000 is worth $10,140,000 at the same multiple. The seller’s adjustments raise the claim to $12,660,000, and the buyer’s accepted adjustments to $11,490,000. The $1,170,000 in dispute is almost all in two lines: $720,000 for savings not yet achieved and $315,000 for the consulting fees that keep coming back. Before a sale, those are the adjustments to test, and the ones a seller can improve by making real.

For a seller, the lesson is to prepare. Document the owner pay against a market wage, keep the settlement papers, separate personal expenses before the sale, and do not lean on savings that have not happened. For a buyer, it is to ask for the support for each item, and to look for recurring costs described as one-time. The business valuation calculator applies a multiple to seller’s discretionary earnings, the version of this used for smaller businesses.

Enterprise value is the value of the operating business before its financing. A common estimate multiplies EBITDA by a multiple. Equity value is what the owners receive: enterprise value minus net debt, which is interest-bearing debt less cash. With $2,400,000 of debt and $300,000 of cash, net debt is $2,100,000.

Net debt does not change with the dispute, so the whole $1,170,000 falls on the owners’ side of the equity value. A 9.2% difference in adjusted EBITDA is an 11.1% difference in equity value here, since the debt is a fixed amount that sits between them. The higher the leverage, the more a small difference in EBITDA shows up in what the owners receive.

The multiple is the other half of the price and the least certain. It reflects growth, margins, the size and quality of the business, the risk of losing customers, and what the market pays that year. The 6.0 times used here is an illustration. Published multiples by industry vary widely and are often unsourced, so the page gives no table of them. Look at actual transactions in the same sector and size range, and treat any single figure as a starting point.

Match the multiple to the definition

A multiple is only meaningful against the EBITDA it was measured on. A market multiple derived from reported EBITDA cannot be applied to an adjusted figure without overstating value, and the reverse understates it. In the example, the same 6.0 times gives $10,140,000 on reported EBITDA and $12,660,000 on the seller’s adjusted figure, a gap of $2,520,000 from the definition alone. When you compare a price with a comparable sale, ask what EBITDA that sale used.

EBITDA leaves out three things that use cash: income taxes, capital expenditures and the growth in working capital. A business can report a comfortable EBITDA and have little left. The bridge from EBITDA to cash takes them out one at a time.

Cash flow before financing is $940,000, or 55.6% of EBITDA. After interest and principal, $390,000 is left for the owners, 23% of EBITDA. Capital expenditures are the largest drain, and EBITDA less capital expenditures alone is $1,310,000, a figure some analysts prefer to EBITDA for that reason. Critics of EBITDA, including Warren Buffett, have long argued that ignoring capital spending flatters companies that must keep investing to stand still.

Cash conversion, the share of EBITDA that reaches cash, is a quality measure in itself. A business at 90% is very different from one at 40%, though both report the same EBITDA. Growth in working capital is a particular trap: a fast-growing company can add receivables and inventory faster than it earns, so that rising EBITDA and falling cash go together. The cash conversion cycle calculator shows how working capital ties up cash. That same $940,000 of unlevered cash flow is the starting point for a full multi-year valuation on the DCF calculator, which projects it forward and adds a terminal value.

Maintenance and growth capital spending

Not every dollar of capital spending is equal. Maintenance spending keeps the current business going, and growth spending adds capacity. Suppose $200,000 of the $380,000 in the example is maintenance. EBITDA less maintenance spending is $1,490,000, a truer picture of what the existing business can distribute, and the other $180,000 is a choice to grow. The calculator uses total spending, and a lender or buyer will often ask for the split.

Lenders use EBITDA to size debt, and they know its limits. Four ratios show how the example looks.

On EBITDA alone the company covers its debt service 3.07 times. After taxes and capital spending it covers it 1.98 times, roughly a third lower. A lender that requires a coverage of 1.25 times passes it on either basis, and one that requires 2.0 times passes it on the first and misses on the second. That is why lenders define coverage in their own terms, and why the definition of EBITDA in a loan agreement is worth reading. The DSCR calculator covers the cash-based ratio in detail.

Net debt to EBITDA, 1.24 times, or 1.10 times on the buyer’s adjusted figure, is the leverage ratio. It says how many years of EBITDA it would take to repay the debt, before taxes and capital spending, and lenders often set a maximum in covenants. The measure moves with the adjustments, which is another reason the definition matters.

Covenant EBITDA

A credit agreement usually defines its own EBITDA, often called consolidated EBITDA, listing the add-backs it permits and sometimes capping them, for example limiting pro forma savings to a percentage of the total. That figure decides whether a company is in compliance with a leverage or coverage covenant. It can differ from the number in a sale process, and from the one on a management report. Read the definition before relying on a headline ratio.

EBITDA margin is EBITDA divided by revenue: 14.1% in the example on reported EBITDA, 17.6% on the seller’s adjusted figure and 16.0% on the buyer’s. One guide says software companies average 30% to 40% or more and retail 5% to 10%. I could not trace these to a source, and they describe very different businesses. Asset-light software companies and asset-heavy manufacturers cannot be compared on this measure, because D&A is added back, and one business needs far more of it than the other.

Use margin to compare a company with its own history and with businesses of the same kind and size. A margin that has risen because of adjustments, and not because of the operations, deserves a second look. So does a margin that looks high in a business that spends heavily on capital equipment, since the spending does not appear in it.

Value a smaller owner-run business with the business valuation calculator, or test whether cash flow covers the debt with the DSCR calculator.