Adjusted ebitda

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

$EBITDA=IN-IE-IT-D-A-NCC$

where:

• 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:

${\frac {EntrepriseValue}{AdjustedEBITDA}}$

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.

Examples of Adjusted ebitda

• Adjusted EBITDA is used to calculate the total value of a company. The formula is used to adjust the company’s earnings before interest, taxes, depreciation, and amortization for one-time costs, such as legal fees, development costs, or other expenses that are not recurring. This helps investors compare companies more accurately and determine what the company is actually worth.
• Adjusted EBITDA is also used to assess a company’s performance from year to year. By taking into account the one-time costs, the investor can get a better understanding of the core performance of the company. For example, if a company has a large one-time expense in one year, such as a legal fee, the adjusted EBITDA will reflect the company’s performance without that expense.
• Adjusted EBITDA is also used to assess the performance of management. By comparing the adjusted EBITDA of one year to the next, the investor can get an indication of whether the management team is doing a good job of running the company. For example, if the adjusted EBITDA has increased from one year to the next, it could be a sign that the management team is doing a good job.

Advantages of Adjusted ebitda

Adjusted EBITDA has many advantages for investors and companies alike. It is useful for assessing the financial performance of companies and for making comparisons across industries. The following are some of the advantages of using Adjusted EBITDA:

• It removes non-operating items from a company's income statement, allowing for a truer comparison of performance between different companies in different sectors.
• It is a measure of operational performance and can be used to assess a company's ability to generate cash flow from its core operations.
• It is not affected by interest payments, taxes, or depreciation and amortization, which allows for more accurate comparisons between companies in different tax brackets, or companies with different capital structures.
• It can be used to assess the value of a company in a merger and acquisition situation, as it eliminates the effects of non-recurring costs.
• It can provide an indication of the underlying profitability of a company and can be used to assess a company's performance over time.

Other approaches related to Adjusted ebitda

The following list contains some of the other approaches:

• Free Cash Flow - This approach measures the cash a company generates after accounting for capital expenditures, such as buildings or equipment, that are needed to maintain or grow the business.
• Return on Investment - This approach measures the profitability of an investment by dividing the gain or loss generated by the investment by the total amount invested.
• Margin of Safety - This approach measures the gap between a company’s current market price and its intrinsic value, which is calculated by subtracting the company’s liabilities from its assets.

In summary, Adjusted EBITDA is one of many approaches used to analyze a company’s financial performance. Other approaches include Free Cash Flow, Return on Investment and Margin of Safety.

Adjusted ebitda — recommended articles

EBITDAR — Market value ratios — Underlying Profit — Combined Ratio — Berry Ratio — Du Pont analysis — Free cash flow yield — Earnings per share — Return on sales — Leadership roles

References

• 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