How to Calculate Adjusted EBITDA With a Formula

Financial analysts often calculate Adjusted Earnings Before Interest, Taxes, Depreciation, and Amortization (Adjusted EBITDA) to gain a clearer perspective on a company’s operational performance. This metric removes the effects of non-recurring, non-cash, or non-operating items that can obscure core profitability. By standardizing earnings, stakeholders can better compare companies and assess their underlying business efficiency, independent of financing decisions, tax structures, or unique events.

The Basis: EBITDA

Earnings Before Interest, Taxes, Depreciation, and Amortization (EBITDA) is a foundational metric in financial analysis. It is derived by taking a company’s net income and adding back interest expense, tax expense, depreciation, and amortization. EBITDA provides a view of a company’s profitability from its core operations, excluding the influence of capital structure, government policies, and non-cash accounting entries.

To calculate EBITDA, start with Net Income from the income statement, then add back interest expense and tax expense. Depreciation and amortization, which are non-cash expenses, are also added back. Depreciation relates to tangible assets like machinery and buildings, while amortization applies to intangible assets such as patents or copyrights. These non-cash charges reflect the allocation of an asset’s cost over its useful life, not current cash outflows.

Alternatively, EBITDA can be calculated by starting with Operating Income (EBIT) and adding back depreciation and amortization. Companies typically report these non-cash expenses within their income statement, and further details can be found in the notes to the financial statements or the cash flow statement.

Common Adjustments

Adjustments to EBITDA normalize a company’s earnings, presenting a more accurate and sustainable picture of its core operational profitability. These modifications remove items not reflective of ongoing business activities or non-cash accounting entries. The goal is to facilitate better comparisons between companies and across different time periods.

Non-Recurring Items

Non-recurring or one-time expenses and income are frequently adjusted to isolate regular operational performance. Examples include significant legal settlements, large-scale restructuring costs such as severance packages, and gains or losses from the sale of non-core assets. These do not stem from the company’s primary business operations.

Other Non-Cash Expenses

Beyond depreciation and amortization, other non-cash expenses are also commonly adjusted. Stock-based compensation, which does not involve a cash outflow, is added back. Impairment charges, reflecting a reduction in asset value, are another non-cash expense added back.

Owner’s Compensation

For privately held companies, owner’s or related-party compensation often requires adjustment. Owners may set their salaries at levels either significantly higher or lower than what a third-party executive performing similar duties would earn. Adjusting this compensation to a market-rate equivalent provides a more realistic view of profitability for potential buyers or investors.

Discontinued Operations

Discontinued operations represent segments of a business that have been sold, disposed of, or are classified as held for sale. The income or loss generated by these operations, along with any gain or loss from their disposal, is typically separated from continuing operations. Adjusting for these items helps focus on the performance of the ongoing business.

Unusual or Infrequent Gains/Losses

Events once classified as “extraordinary items” are now considered “unusual or infrequent” gains or losses. Examples include those arising from natural disasters or large, infrequent legal judgments. These items are adjusted to prevent distortion of a company’s recurring profitability.

Non-Operating Income and Expenses

Non-operating income and expenses are not directly tied to a company’s primary business activities. These can include gains or losses from investments, foreign exchange fluctuations, or interest income not related to core business lending. The aim is to isolate the profitability solely generated by the company’s main operational activities.

Calculating Adjusted EBITDA

Calculating Adjusted EBITDA involves a systematic process that begins with the core EBITDA figure and then incorporates various normalizing adjustments. This calculation aims to eliminate the impact of non-recurring, non-cash, or non-operating items, providing a clearer view of a company’s sustainable operating performance. The first step is to determine the standard EBITDA, typically by taking Net Income, adding back interest expense, tax expense, depreciation, and amortization, all sourced from the company’s income statement and cash flow statement.

Once the initial EBITDA is established, the identified adjustments are systematically applied. Non-recurring expenses, such as one-time legal fees or significant restructuring costs, are added back to EBITDA. Conversely, non-recurring income, like a large, infrequent gain from an asset sale, would be subtracted. Non-cash expenses beyond depreciation and amortization, such as stock-based compensation, are also added back, as they do not represent actual cash outflows.

For private companies, an important adjustment involves owner’s compensation. If an owner’s salary or benefits are significantly above or below the market rate for a similar role, the difference is adjusted. This normalization helps potential buyers assess the business’s true operating profitability.

For example, if a company has an EBITDA of $1,000,000, incurred $100,000 in one-time restructuring costs, had $50,000 in stock-based compensation, and a $20,000 gain from selling old equipment, the Adjusted EBITDA would be $1,000,000 + $100,000 + $50,000 – $20,000 = $1,130,000. Data for these adjustments are typically found in a company’s financial statements, footnotes, and internal accounting records.