How to Calculate EBITDA

The EBITDA formula

EBITDA stands for earnings before interest, tax, depreciation and amortisation. There are two equivalent routes to it, and it is worth knowing both because different sets of accounts hand you a different starting line.

Both routes should produce the same number for the same period, because operating profit is already net income with interest and tax added back — the second formula is simply the first with that step already done. If your two routes disagree, the mismatch is almost always a figure sitting in the wrong place in the accounts, not a real difference in EBITDA.

Why buyers use it

Interest depends on how a business happens to be financed, not on how well it trades. Tax depends on its jurisdiction, its losses carried forward and decisions that have nothing to do with operating performance. Depreciation and amortisation are non-cash accounting charges that spread the cost of past capital spending over time, rather than cash leaving the business in the period being measured. Stripping all four out gives a figure that is closer to comparable across businesses with different capital structures, tax positions and asset ages — which is exactly what a buyer needs when comparing a target against precedent transactions or applying a multiple drawn from other deals.

That comparability is also EBITDA's limit. It says nothing about how much of the business's own cash actually reaches the bottom line once real capital spending and working capital movements are accounted for — two businesses with identical EBITDA can need very different amounts of ongoing investment to sustain it.

Calculating it step by step from a real set of accounts

1. Start with the profit and loss account (income statement) for the period you are measuring — usually the most recent filed or management accounts year.
2. Find net income (profit for the year, after tax) at the bottom, or operating profit if that is the lowest line the accounts show.
3. If starting from net income: add back the tax charge for the year, then add back net interest (interest paid less interest received) — this gets you to operating profit (EBIT) as a checkpoint.
4. Add back depreciation of tangible fixed assets for the period. Small-company accounts usually show this in the notes to the accounts rather than on the face of the profit and loss account.
5. Add back amortisation of intangible assets (goodwill, capitalised software, acquired customer relationships) for the period, also usually in the notes.
6. The total is EBITDA for that period, before any normalisation adjustments.

Adjusted EBITDA: the figure a buyer actually prices

Raw EBITDA, calculated exactly as above, is rarely the number a deal is priced on. Owner-managed and closely held businesses carry costs and benefits that would not recur under new ownership, and normalising for them — turning raw EBITDA into "adjusted EBITDA" — is standard practice on both sides of a transaction. The adjustments that are usually defensible:

• Above-market owner remuneration. If the owner draws £150,000 and a market-rate manager doing the same job would cost £70,000, the £80,000 difference is added back — but only the difference, and only with a comparable salary benchmark to justify the market rate used.
• Genuinely one-off costs. A one-off legal dispute, a relocation, a bad debt that will not recur — added back if the cost is clearly non-recurring and documented, not simply unusual-looking.
• Related-party rent above or below market. If the business pays the owner's connected property company rent above (or below) what an arm's-length lease would cost, the difference is adjusted to a market rate.
• Discontinued activities. Revenue and costs from a product line, contract or site that has genuinely ceased, where the remaining business is what is being valued.

What is not usually defensible: recurring costs relabelled as one-off because they happened to be large this year, a market-rate salary add-back with no benchmark behind the "market rate" claimed, or a forecast saving dressed up as a historical adjustment. Red flags when buying a business covers how buyers test add-backs that will not stand up; every adjustment should be a line a reader can trace to a specific cost and a specific piece of evidence, not a round number knocked off the top.

EBITDA margin

EBITDA margin is EBITDA divided by revenue, expressed as a percentage — a business with £2m revenue and £400,000 EBITDA has a 20% EBITDA margin. It is useful for comparing profitability between periods or against sector peers on a like-for-like basis, independent of the absolute size of the business.

EBITDA, SDE, operating profit and net profit — which figure is which

EBITDA is one of several earnings figures that get confused with each other in an acquisition, and using the wrong one against the wrong multiple is one of the more expensive mistakes a first-time buyer makes.

SDE and EBITDA are not interchangeable, and applying an EBITDA-based multiple to an SDE figure overstates the price by the multiple times the owner's add-back. EBITDA vs SDE in business acquisitions covers the bridge between the two figures and which one applies to your target.

A worked example

Common mistakes

• Adding back depreciation twice. If you start from operating profit, depreciation and amortisation are already excluded from the net income line above it — check which starting point you used before adding anything back.
• Treating every unusual-looking cost as one-off. A cost is only a genuine add-back if it is documented and will not recur; "this looks big" is not evidence.
• Using an EBITDA-based multiple on an SDE figure, or vice versa. The two are not the same number and pricing the wrong one against the wrong multiple can overstate or understate a fair price by a wide margin.
• Treating EBITDA as cash in the bank. It ignores capital expenditure and the year-on-year movement in working capital, both of which are real cash draws — a growing business can show strong EBITDA and still be absorbing most of it into stock and debtors.
• Stating a "typical" multiple as a fact. Multiples vary by sector, size, growth and deal-specific factors, and quoting a single rule-of-thumb number without comparable evidence behind it is a guess dressed up as a benchmark.

How TrueValue reads EBITDA from your accounts

Dropping a target's accounts into TrueValue reads the income statement, balance sheet and working capital into figures you can check line by line, rather than a summary you have to take on trust — the same arithmetic set out above, applied automatically to whatever the document actually states. The valuation engine then runs on that base figure and, where a quality-of-earnings review has been done on the deal, prefers the normalised EBITDA it establishes over the raw figure. Adjustments are shown as a visible bridge from the reported number, never folded silently into one line, and a figure the accounts do not state stays blank rather than being estimated. The EBITDA multiple calculator is a free way to see the arithmetic between an EBITDA figure, a multiple and a resulting enterprise value without creating an account.