What is adjusted EBITDA?
Adjusted EBITDA (earnings before interest, taxes, depreciation, and amortization) is a metric calculated for a company that takes earnings and subtracts interest, taxes, and depreciation charges, as well as other adjustments. By removing anomalies from EBITDA, the resulting adjusted or normalised EBITDA is more accurately and easily comparable to the EBITDA of other companies and the EBITDA of a company's industry as a whole.
Uses of adjusted EBITDA
Adjusted EBITDA is used to evaluate and compare related companies for valuation purposes, among other things. Adjusted EBITDA differs from standard EBITDA in that it is used to normalise a company's income and expenses because different companies may have various types of expense items that are unique to them. In contrast to the non-adjusted version, adjusted EBITDA attempts to normalise income, standardise cash flows, and eliminate anomalies or idiosyncrasies (such as redundant assets, bonuses paid to owners, rentals above or below fair market value, and so on), making it easier to compare multiple business units or companies in a given industry.
Advantages and disadvantages of adjusted EBITDA
Advantages
- EBITDA is similar to the price-to-earnings ratio in some ways (PE ratio). The advantage of EBITDA is that, unlike the PE ratio, it is unaffected by capital structure. It mitigates the risk of factors influenced by capital investment and other financing variables.
- EBITDA demonstrates how well ongoing operations generate cash flow. It also shows the monetary value of the cash flow.
- It can indicate whether the company is appealing to potential investors as a leveraged buyout candidate. EBITDA can provide a comprehensive picture of growth. This can demonstrate how well the business model is functioning.
- Debt is not transferred to the buyer when a company is purchased. As a result, a buyer won't care how the company is funded at the time of sale. Customers and cash flow may be more important to buyers than asset age or interest on current debts.
Disadvantages
- By adding taxes and interest back to earnings, EBITDA ignores the cost of debt. It can be used to conceal poor decisions and financial shortcomings.
- Using EBITDA may prevent you from obtaining a loan for your business. Loans are based on the actual financial performance of a company.
- Patents and copyrights expire over time. Machines, tools and other assets lose value and utility. EBITDA does not account for or acknowledge these costs.
- EBITDA disregards or conceals high-interest financial burdens.
