Adjusted EBITDA is one of measures that describe company performance. The EBITDA means: Earnings Before Interest, Taxes, Depreciation and Amortization. The adjustation normalizes income and expenses in order to allow comparisons between companies. Every company can treat types of incomes/expenses differently, which can lead to misinterpretation. Normalization solves that problem. Adjusted EBITDA is better than normal EBITDA because include normalize income, standardize cash-flows and eliminate situations like bonuses paid to owners, rentals above or below fair market value. Adjusted EBITDA is a useful way to compare companies across and within an industry. Many consider it a more accurate reflection of the company's worth as it adjusts for and negates one-time costs such as lawsuits, startup or development expenses, or professional fees that are not recurring
How to calculate adjusted EBITDA
- IN - net income,
- IE - total interest expenses
- IT - income taxes
- D - depreciation
- A - amortization
- NCC - non-cash charges (share-based compensation)
Measurement is typically done on an annual basis, but big number of analysts looks at bigger amount of time, like 3 or 5 years and counts the average adjusted EBITDA, because in that way it is more reliable. Every company want as high adjusted EBITDA as possible, because it shows how good is company situation.
Limitations of adjusted EBITDA
It is important to note that adjusted EBITDA is not a Generally Accepted Accounting Principles (GAAP) standard line item on a company's income statement and non-GAAP financial measures are not based on any comprehensive set of accounting rules or principles (Sui, Y. 2017). As every financial measure, adjusted EBITDA should not be used alone in analysis. It can lead to misinterpretation. It is worth trying ratios based on adjusted EBITDA, for example:
Differences between EBITDA and adjusted EBITDA
EBITDA and adjusted EBITDA have some differences. Calculating the EBITDA margin allows analysts and investors to compare companies of different sizes in different industries because it formulates operating profit as a percentage of revenue. Adjusted EBITDA indicates top line earnings before deducting interest, tax, depreciation and amortization. It normalizes income, standardizes cash flow, and eliminates abnormalities often making it easier to compare multiple businesses.
- Folster, A., & Camargo, R. V. W., & Vicente, E. F. R. (2015) Management earnings forecast disclosure: A study on the relationship between EBITDA forecast and financial performance Revista de Gestão, Finanças e Contabilidade, v. 5, n. 4 (2015).
- Hamilton, B. (2003). EBITDA: still crucial to credit analysis. Commercial Lending Review, 18(5), 47-48.
- Iotti, M., & Bonazzi, G. (2012). EBITDA/EBIT and cash flow based ICRs: A comparative approach in the agro-food system in Italy Financial Assets and Investing, No. 2/2012.
- Sui, Y. (2017). The Research on the Applications and Limitations of EBITDA. 2nd International Conference on Sustainable Energy and Environment Protection (ICSEEP 2017).
Author: Piotr Budz