;)
EBITDA & CAPEX
EBITDA is crucial for accurately assessing the financial health of smaller businesses, requiring adjustments for non-typical or owner-related revenues and expenses.
EBITDA Meaning
Earnings before interest, tax, depreciation, and amortization (EBITDA) is a measure of the cash flow of a business. EBITDA is calculated as follows:
Net income before taxes + Interest on long-term debt + Depreciation and amortization
Normalized EBITDA
Smaller, privately owned businesses typically require additional adjustments to EBITDA:
- Revenues or expenses that are not typical or non-recurring
- Revenues or expenses that are related to the owner, not to the business
The resulting figure is referred to as Normalized EBITDA or Adjusted EBITDA. Determining these adjustments requires a detailed analysis of all revenue and expense accounts.
Some Examples of EBITDA Adjustments
- Owner’s salary or bonuses that are higher or lower than their fair market value
- Rent for the business premises that is higher or lower than fair market value
- Family members who are on payroll, but don’t work in the business
- Revenue or expenses resulting from settlement of a lawsuit or insurance claims
- One-time legal or accounting fees for an unusual event
- Capital items (assets) that are expensed to reduce tax
- Repair costs resulting from a flood or fire (one-time cost)
- Interest from investments, as these are not considered an asset necessary to business operations
- Expenses for assets not necessary for operations, like the owner’s cottage or boat
- Discretionary expenses of the owner, such as fishing trips that are booked as a business expense, or other items that the buyer wouldn’t see as a necessary business expense
- Gains or losses from the disposal of assets that aren’t necessary to business operations
- Unusual foreign exchange gains or losses
“If you work just for money, you’ll never make it, but if you love what you’re doing and you always put the customer first, success will be yours.” – Ray Kroc
Adjusting for Capital Expenditures (CAPEX)
Finally, the normalized EBITDA figure should be adjusted for average anticipated Capital Expenditures (CAPEX)—the annual amount required to maintain or upgrade the operating equipment of the business at the current level of revenue. This can vary considerably from business to business, and industry to industry. Service businesses typically have low investments in operating equipment, while a construction company or manufacturer usually has a large investment in operating equipment.
The amount required annually for CAPEX reduces the expected future cash flow of the business and the buyer’s ROI.
Business Valuation Report
It’s very easy to get caught up in all the formulas, industry standards, and different business valuation methods. That’s why we designed our ‘Business Valuation Model’,which is intended to help the average business owner understand how business value is derived in a straightforward and logical way.
After providing more than 5,000 opinions of value over the past decade, we are well positioned to provide you with a comprehensive report on the value of your business. If you would like to know what your business is worth, contact us to order your business valuation report.
