What is adjusted EBITDA?

Definition

Adjusted EBITDA is EBITDA after owner pay or one-time items have been normalized out. On the books, this is a computed figure, not a GAAP line on the Income Statement and not cash in the bank.

A founder-run coffee roaster uses it when the owner's salary sits above a market rate, or when a one-time move hit the year. The add-backs are the point of this reading.

It is not a ledger account with a running balance. Someone starts from EBITDA and then lists the items being added back.

Stay with those adjustments when you read the figure. A different list of add-backs will produce a different leftover from the same year.

Where it shows up

P&L: Related to EBITDA after add-backs. Not a GAAP line.

Cash flow: Related to cash from operations, which this number is not.

See also: EBITDA · EBITDA Margin · Operating Income

When you look at your Income Statement, this figure is not its own printed account. It starts from EBITDA, which itself starts from operating income with depreciation and amortization added back.

When the figure is high, the add-backs were large, or the starting leftover was strong. When it is low, there was little to normalize, or core work left less.

The Balance Sheet does not print this figure. Owner pay still sits in wage cost; a move still sat in the period's expenses until someone listed it as an add-back.

On the Statement of Cash Flows, cash from operations is a different reading. Adding back a salary or a move does not put that cash in the till.

A financial statement package may show this figure on a schedule after the statements. The schedule should list each add-back so a reader can see what was normalized.

A loan agreement may name this figure in a covenant. The agreement's definition of the add-backs is the one that counts for that test.

How it works

Start with this period's EBITDA. That figure is already operating leftover with depreciation and amortization added back.

List the owner or one-time items you are treating as not part of ongoing work. Add those amounts back, or subtract them if you are taking a below-market item down.

• Start with this period's EBITDA.
• List owner or one-time items that are not part of ongoing work.
• Add those amounts back (or subtract a below-market item).
• Read the result as adjusted EBITDA—quality depends on the add-back list.

A common add-back is owner salary above a market rate for the role. The extra pay was an expense; adding it back asks what leftover would have been at a market wage.

A common add-back is a one-time cost, such as moving the roaster to a new suite. The move hit this year; it is not expected to repeat in the same way.

What you have after those items is adjusted EBITDA. The quality of the figure depends on how honest and complete the add-back list is.

Stay with the list when you read it. Two people can start from the same EBITDA and reach two different adjusted figures if they pick different items.

Do not treat an owner's draw as an add-back. A draw is cash taken out of equity, not an expense that reduced EBITDA in the first place.

Do not treat this figure as cash. The add-backs are paper normalizations; they do not move the bank account.

Example

Kiln & Bean, a founder-run coffee roaster, posts $120,000 of EBITDA this year. The founder paid herself $90,000; a market wage for the role would have been $50,000.

The extra $40,000 of owner salary is an add-back. The roaster also spent $10,000 on a one-time move to a new suite.

Add $40,000 and $10,000 to the $120,000. Adjusted EBITDA is $170,000.

The $170,000 is not cash sitting in the roasting room. The extra salary was paid, and the move was paid; the add-backs only restate the leftover.

If the founder had taken a $20,000 draw instead of extra salary, that draw would not be an add-back. It never reduced EBITDA, because it was not an expense.

A second one-time item, such as a $5,000 repair after a small fire, would raise this figure to $175,000 if it were added back. Each item belongs on the list, with a reason.

Common mix-ups

Adjusted EBITDA is not the same as EBITDA. EBITDA adds back depreciation and amortization only; this figure also normalizes owner or one-time items.

Adjusted EBITDA is not the same as an owner's draw. A draw is equity, not an expense, so it is not an add-back.

Adjusted EBITDA is not the same as cash. The add-backs restate leftover; they do not collect from customers or pay the mill.

Related terms

• EBITDA: Earnings before interest, taxes, depreciation, and amortization.
• Operating Income: Profit from core operations before interest and taxes.
• Owner's Draw: Cash an owner takes out of the business for personal use.
• EBITDA Margin: EBITDA as a percentage of revenue.
• Net Income: What is left from revenue after every expense, including interest and taxes, is subtracted.
• Non-Cash Expenses: Charges that reduce profit without moving cash.
• Financial Statement Package: The bundled set of statements and schedules delivered after a close.
• Covenant: A condition in a loan agreement the borrower must keep meeting.