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Business Valuation

Normalized EBITDA

EBITDA adjusted to remove unusual, non-recurring, or discretionary expenses to better estimate a business's value

Business Valuation

In Summary

Normalized EBITDA is a key component to estimating the value of a client's business. It represents a business's ability to generate earnings in the future based on historic earnings and adjustments to remove unusual, non-recurring, or discretionary expenses to better reflect true earnings.

Adjusting earnings for business valuation is a nuanced and complex task. Work with your client and their accountant directly to identify which expenses make sense to "add-back" to normalize EBITDA when estimating business valuation.

How to normalize earnings with "add-backs"

Most businesses have some amount of expenses that are not directly critical to operations.

Since "the market" (hypothetical prospective buyers) will remove any non-critical expenses to realize full earning potential, historic earnings need to be adjusted for there discretionary or unusual expenses to better estimate what the value of the business may be. This process of "adding-back" expenses normalizes earnings to better reflect the business's true valuation.

Estimating normalized EBITDA

Normalized EBITDA = Weighted Average of Historic EBITDA + Adjustments to Normalize EBITDA

Without normalizing earnings by including add-backs, your client's business value may be underestimated. Likewise, if add-backs are overstated this may lead to overestimates of valuation.

Example "add-back" expenses

Examples of expenses that may be added back to normalize EBITDA include:

  • Profit sharing or incentive compensation plans. This may include expenses around pension plans, 401K profit sharing, deferred compensation plans, and profit sharing incentives.
  • Excess owners compensation expense above what a replacement salary would cost. Owners work hard to build income generating businesses and have every right to pay themselves well as a result! In the event they transition ownership, the business will have to pay someone to replace the owner's functional role. The difference between what the business would pay a replacement of the owner and what the owner is earning today may be considered an add-back expense in some cases.
  • Strategic and/or one time expenses not directly tied to current operations. This may include salaries, technology investments, or professional fees associated with future growth initiatives or one time projects.
  • Discretionary expenses. Any expenses that are considered at the owner's discretion and not critical to maintaining current operations. This may include charitable contributions, excess travel costs, country club fees, and culture-building type of expenses.

Request an estimate of "add-backs" from clients

It's best to work with your client or their accountant to understand if they have any of these types of expenses and consider if an appropriate adjustment is needed to normalize earnings.

Identifying which expenses used to normalize EBITDA is a nuanced and complex task and is a difficult exercise to conduct by looking at the typical business tax return alone.

Asking clients about what expenses are not critical to operations is the best way to capture this data.

Frequently Asked Questions