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How To Calculate EBITDA Add-Backs

Garry Stephensen

Article Author: Garry Stephensen
Position: Managing Director
Read time: 5 mins

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In the arena of corporate finance, where every dollar counts and valuation is paramount, understanding the nuances of financial metrics can make all the difference. One such metric that holds particular significance in the realm of business sales, especially within the Australian market, is "EBITDA add-backs".

What are EBITDA Add-Backs?

EBITDA is an acronym for "Earnings Before Interest, Taxes, Depreciation, and Amortization". This serves as a widely-accepted measure of a company's operational performance, providing insight into its core profitability without the impact of financing and accounting decisions.

"EBITDA add-backs" are adjustments made to the EBITDA figure to reflect certain expenses or non-operating items that are not representative of the company's ongoing operations. These adjustments are carefully calculated when preparing a business for sale, with the aim of presenting a clearer picture of the business's true earnings potential by excluding items that might be one-off or non-recurring in nature.

Optimizing EBITDA Presentation through Thoughtful Adjustment Considerations

In the realm of enhancing business valuation, the accurate portrayal of EBITDA figures during a sales process holds paramount significance. To achieve this precision, strategic consultants wield the tool of EBITDA "add backs," effecting the removal or inclusion of expenditures to facilitate an authentic depiction of the business's historical and future profitability.

As seen in the Financial Review and the Courier Mail.

These EBITDA "add backs" can assume either a favorable or unfavorable orientation.

Favorable Adjustments

Favorable adjustments entail the elimination of expenses, thus augmenting EBITDA figures. This positive transformation can be classified into two overarching categories:

Once Off Expenditures: These are financial outlays anticipated as singular occurrences without anticipation of recurrence. Notable examples encompass legal fees and restructuring costs.

Personal Disbursements: Pertaining to personal expenditures of Founder(s), borne by the enterprise. Instances encompass costs tied to motor vehicles and international travel. Often, such personal expenses are routed through the business to mitigate tax obligations.

For example:

  • Personal motor vehicle expenses, spanning registration, insurance, maintenance, and fuel.
  • Conversion of shareholder dividends into bonuses.
  • Mitigation of litigation expenses
  • Integration of historically "off the books" cash-based revenues.

Unfavorable Adjustments

While some advisors may artificially elevate EBITDA via adjustments, adjustments may also be considered as unfavorable. Importantly, the objective of adjustments is to encapsulate the authentic earnings of the enterprise. These generally include two central categories:

  • Related-Party Expenditures
    These outlays are waived or subject to significant reductions due to the parties involved being related entities. Illustrations involve instances where the Founder CEO forgoes salary and when below-market rent is paid for premises owned by a Parent Company.

  • Non-Operational Earnings
    These encompass extraordinary gains from non-operational activities, including asset sales and insurance recoveries.

For example:

  • Exclusion of income from a substantial, isolated foreign exchange gain.
  • Inclusion of wage expenditure to bridge the compensation gap between the Founder CEO's remuneration and the market norm for a CEO of comparable competence and experience.
  • Removal of revenue sourced from a significant, one-off insurance recovery.
  • Addition of rent expenditure for premises utilized by the business, owned by the Founder's family trust.

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The Significance of EBITDA Add-Backs for Sales

For business sellers in Australia, EBITDA add-backs play a pivotal role in influencing the valuation and benchmarking of a company. It is critical in achieving the best price for your business. Potential buyers often assess the attractiveness of an acquisition based on the projected cash flow that the business can generate. EBITDA serves as a proxy for cash flow, providing an insight into the company's operational profitability before the impacts of financing and accounting practices.

However, many businesses incur certain expenses that, while impacting the current financials, might not accurately reflect the future earning potential of the business under new ownership. These expenses can include non-recurring costs, owner perks, or discretionary expenses that may not persist post-acquisition. By adding back these expenses to the EBITDA figure, sellers can present a more accurate representation of the business's potential earnings to prospective buyers.

The importance of EBITDA add-backs can be best understood through an example. Consider a manufacturing company in Australia that is up for sale. The business has recently undertaken a significant rebranding campaign, incurring substantial marketing expenses. While these expenses negatively impact the current EBITDA, they are unlikely to recur after the sale. By adding back these marketing expenses to the EBITDA figure, the seller can present a more attractive financial picture to potential buyers, showcasing the business's ability to generate higher cash flows post-acquisition.

Example Calculation of EBITDA Add-Backs:

Let's break down the calculation of EBITDA add-backs using a hypothetical scenario involving a retail business in Australia:

ItemAmount (AUD)
Non-recurring legal expenses-$20,000
Owner's discretionary expenses-$15,000
Interest expenses-$30,000
Adjusted EBITDA$325,000

In this example, the non-recurring legal expenses and owner's discretionary expenses are considered add-backs, as they are not indicative of the business's ongoing operations. By adding back these expenses to the EBITDA figure, the adjusted EBITDA paints a more accurate picture of the business's earning potential under new ownership.

EBITDA Add-Backs:  Their Significance in Business Sales

In the intricate dance of business sales, EBITDA add-backs emerge as a strategic tool for sellers in Australia to maximize the value of their enterprises. By meticulously identifying and quantifying non-recurring expenses and discretionary costs, business owners can present a more accurate representation of their company's potential earnings. As evidenced by data and statistics, leveraging EBITDA add-backs in negotiations can lead to not only higher acquisition prices but also more favorable terms for both parties involved. In the ever-evolving landscape of corporate finance, mastering the art of EBITDA add-backs stands as a testament to a seller's astuteness and their ability to secure a more prosperous future.

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