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    How to Calculate Adjusted EBITDA

    Walk through the formula and understand why each adjustment matters

    3 min read

    🔧 Tool: Earnings Calculator

    Key Takeaways

    • EBITDA is net income plus interest, taxes, depreciation, and amortization

    • "Adjusted" means the seller removed expenses they claim will not continue under new ownership

    • EBITDA is not cash flow. It ignores working capital swings and required capital expenditures

    • Every adjustment needs documentation that satisfies you, your lender, and your Quality of Earnings ("QoE") team

    • Overstate EBITDA and you can overpay fast. Multiples magnify mistakes

    Adjusted EBITDA is simple to calculate and easy to abuse.

    The base formula is straightforward. The adjustments are where buyers get trapped.

    The base calculation

    What EBITDA measures (and what it ignores)

    Start with net income. Add back interest, taxes, depreciation, and amortization. That gets you EBITDA.

    EBITDA is a useful operating earnings metric. It strips out capital structure and some accounting noise. It is not cash flow. It ignores changes in working capital and the capital expenditures required to sustain the business.

    Debt service is paid with cash, not EBITDA. Keep that distinction in your head when you look at any broker's "adjusted" number.

    What "adjusted" actually means

    Common categories, common abuse

    Adjusted EBITDA is EBITDA plus add-backs the seller claims will not exist post-close. The usual buckets are:

    • Excess owner compensation (above market replacement cost)

    • Personal or discretionary expenses run through the business

    • One-time, non-recurring items (true anomalies, not patterns)

    • Related-party rent normalization (to market)

    Each one can be legitimate. Each one can also be a story.

    The three-audience test

    If one says no, the add-back is not real

    Before you accept any adjustment, run it through three filters:

    1. You: does it make sense as the new owner? Would you actually stop paying it?

    2. The lender: will the bank underwrite it, or haircut it for being aggressive?

    3. QoE: can a CPA diligence it with real support?

    If you are missing documentation, assume the lender and QoE will say no.

    A quick example of how this breaks deals:

    • Seller presents $1.0M adjusted EBITDA.

    • QoE removes $300K of unsupported add-backs.

    • Bank sizes debt to $700K of real earnings, not the $1.0M story.

    • Your leverage shrinks or your equity check grows. Either way, price has to move.

    At a 4x multiple, every $100K of add-backs you accept but should not is $400K of price.

    What's Next

    Before you sign an LOI:

    1. Rebuild adjusted EBITDA from the financials and list every add-back.

    2. Label each one: accept, reject, or verify (with the support you need).

    3. Run a haircut case where the weakest 20% to 30% get removed and size your offer to that case.

    What this does not cover: normalized capex and working capital targets. Those can change your real cash flow even if adjusted EBITDA is correct.

    Use the Earnings Calculator

    Build EBITDA from net income, then itemize add-backs and run a haircut case. Use it before LOI so you know which version of EBITDA your deal can survive. Output: adjusted EBITDA by scenario.

    → Earnings Calculator

    Sources

    • U.S. Small Business Administration, SOP 50 10 (Version 8, effective June 1, 2025)

    • BDO, "Purchase Price Wars: EBITDA vs. Adjusted EBITDA and Why It Matters"

    • CBIZ, "Understanding Adjusted EBITDA"

    • Investopedia, "Key Differences Between Cash Flow and EBITDA"