What EBITDA actually is
EBITDA stands for Earnings Before Interest, Taxes, Depreciation, and Amortization. Starting from net income, add back these four items to get to EBITDA. The goal is to approximate operating cash flow before capital structure and tax considerations.
Interest is added back because it depends on how the company is financed. A company with significant debt has high interest expense; the same company with no debt has none. For buyers evaluating the underlying business, interest expense is not relevant because they will set their own capital structure.
Taxes are added back because they depend on the company's tax structure, jurisdiction, and prior losses. Depreciation and amortization are added back because they are non-cash expenses. The company did not spend cash in the current period; those are allocations of prior capital expenditures. Adding them back gets closer to cash-based operating performance.
Why buyers use it for valuation
EBITDA strips away financing and accounting choices to reveal operating performance. A buyer can compare EBITDA across companies with different capital structures and different asset bases. Revenue and net income vary too much based on other factors; EBITDA gets closer to apples-to-apples comparison.
EBITDA multiples (price divided by EBITDA) are the standard valuation shorthand. A company with $5M EBITDA selling for $30M is trading at 6x EBITDA. Buyers know typical multiples for different industries and company types, so EBITDA multiples make valuation negotiations tractable.
The multiple varies by industry, growth rate, recurring revenue, and competitive dynamics. Software businesses with recurring revenue trade at higher multiples than services. Faster-growing companies trade higher than slower. Recurring revenue trades higher than project-based. These variations are the negotiation.
Adjusted EBITDA
Buyers often use "adjusted EBITDA" which adds back or removes one-time items to get to a normalized number. One-time legal settlements. Owner salaries above market rates. Related-party transactions. Non-recurring consulting fees. The goal is to isolate the sustainable operating performance.
Sellers usually push for more adjustments (higher EBITDA). Buyers usually push for fewer (lower EBITDA). This tension is much of the valuation negotiation. Having clean, documented financials makes the conversation easier because the one-time items are identifiable.
Quality-of-earnings analyses performed during diligence examine these adjustments carefully. A buyer's accounting advisors will challenge add-backs that look aggressive, demand documentation for one-time items, and adjust EBITDA to what they consider defensible. The result often differs from what the seller proposed.
What sellers should track
Track trailing 12-month (TTM) EBITDA monthly. Buyers use TTM EBITDA as the primary valuation input, so knowing what it is at any given time matters. Also track it on a "quality-adjusted" basis - EBITDA with defensible add-backs included.
Document one-time items as they occur. A $200K legal settlement in March should be documented as non-recurring in real time, not reconstructed during diligence. This documentation supports add-back arguments later.
Know the multiples in your industry. If similar businesses are selling at 6-8x EBITDA, that is the range you are working in. Expecting 12x when comparables trade at 6x wastes everyone's time. Get realistic benchmarks early.