A Small Business Owner's Guide to EBITDA

As a business owner, you probably know your annual sales by heart. You might even have a good handle on your bottom-line profit. But here is what most small business owners don’t realize: when it comes time to sell, buyers aren't looking at sales or profits – they're focused on your EBITDA, a measure of your business's true operating profitability.

This knowledge gap leads many owners to make costly mistakes during a sale like:

• Overestimating the value of their business by 300-400% when using sales figures, causing them to reject great offers

• Undervaluing their business by 50% or more when using net profit, leaving life-changing money on the table

Understanding these financial terms might seem daunting and overwhelming - but it doesn’t have to be. In this article we will teach you everything you need to know about measuring your business’s true profitability and how to apply it to valuing your business.

In this article, you'll learn:

• What EBITDA is and why buyers care about it more than other metrics

• How to calculate your base EBITDA from your financial statements

• Which adjustments can legitimately increase your EBITDA

• How to use EBITDA to estimate your business's market value

• How to increase your EBITDA (and the value of your business)

What is EBITDA?

EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization) reveals your business's true operational performance by stripping away factors that can vary widely between companies.

Let's look at a real example of two manufacturing businesses to see why a correct EBITDA calculation matters so much:

Despite showing identical net profits, Company A is actually twice as valuable to buyers! Why? Because their net profit is impacted by:

• Higher interest payments (which a new owner could refinance at a lower interest rate or avoid using debt altogether)

• Higher taxes (could be due to a different tax jurisdiction or business structure)

• More investment in equipment in the past (showing up as depreciation, even though not a cash expense)

These factors mask the fact that Manufacturer A's core operations generate twice the cash flow of Manufacturer B.

💡 Quick Tip: Your business's EBITDA can be 2-3x higher than the net profit you reported on last year's tax return. This is why knowing your true EBITDA is crucial when talking to potential buyers.

How to Calculate Your EBITDA

EBITDA adds back four key expenses to your net profit. Here's why each one matters:

⚠️ Common Mistake: Don't forget to include all interest payments, including those on equipment loans and business lines of credit.

Making Adjustments to Your EBITDA

After calculating your base EBITDA, the next critical step is identifying legitimate adjustments. These adjustments help present a more accurate picture of your business's true earning potential under new ownership.

There are two primary types of EBITDA adjustments:

1. Non-Business Expenses

These are personal or family expenses that many small business owners run through their company for tax advantages. While this practice reduces taxes, it also artificially lowers your EBITDA. Common examples include:

• Personal vehicle expenses

• Family members on payroll

• Personal travel or entertainment

• Personal insurance policies

• Owner's salary above market rate

• Home office expenses

2. Non-Recurring Items

These are one-time costs or revenue spikes that don't reflect your business's normal operations. Including these would distort the true "steady state" picture of your business. Examples include:

• Legal settlements

• Moving expenses

• Equipment repair/replacement

• COVID-related impacts

• Natural disaster costs

• One-time project revenue

• Startup costs for new locations

Real-World Example: From Base to Adjusted EBITDA

Let's look at how these adjustments can play out for a manufacturing company:

💡 Quick Tip: Document these adjustments throughout the year with clear explanations and supporting evidence. Buyers will scrutinize every adjustment during due diligence.

⚠️ Warning: While it's important to identify all legitimate adjustments, being too aggressive with add-backs can damage your credibility with buyers. Each adjustment should be clearly defendable and well-documented.

What Makes a Good Adjustment?

Strong EBITDA adjustments share these characteristics:

1. Clearly personal or non-recurring in nature

2. Well-documented with supporting evidence

3. Would definitely not continue under new ownership

4. Conservatively calculated

5. Common industry practice

Using EBITDA to Value Your Business

When valuing your business, industry matters - a lot. Just like homes in different neighborhoods command different prices, businesses in different industries typically sell for different EBITDA multiples. Think of an EBITDA multiple as a price tag for your business based on its yearly profits.

Here is a simple example:

• If similar businesses in your industry typically sell for 4-5x times EBITDA, and

• Your business makes $1 million in Adjusted EBITDA, then

• You might expect to sell your business for around $4-5 million.

With that said, even companies within the same industry can trade at significantly different multiples, depending company specific characteristics such as revenue recurrence, customer diversity, and others.

To illustrate this point, let’s take a look at the plumbing industry, which typically attracts valuation multipliers of 3-6x - but which one is the most appropriate for your business?

The service business is worth more than twice as much because:

1. Predictable revenue: Long-term maintenance contracts vs. project-based work

2. Customer diversity: 200+ buildings vs. 3 main contractors

3. Economic protection: Buildings need maintenance in any economy

Figuring out the right multiple for your business can be challenging (here is an article that explains how to do it). But as a general rule of thumb, here are some of the factors that can increase of decrease the valuation multiplier for your business:

Think of these as the "curb appeal" factors for your business:

• Size matters: Generally, larger businesses command higher multiples

• Growth trajectory: Consistent growth trends can push you toward the higher end

• Competitive position: Strong market share or unique advantages boost multiples

• Customer diversity: Less reliance on any single customer improves valuations

• Management strength: A strong team that will stay post-sale adds value

💡Quick Tip: An experienced M&A advisor will be able to give you a better estimate of what your business is worth based on their data on past similar transactions, as well as their deep understanding of how buyers view and assess acquisition opportunities in your industry.

Making EBITDA Work for You

Improving and tracking your EBITDA doesn’t have to be complicated. By implementing a few straightforward practices, you can consistently monitor your business’s operational profitability and set yourself up for long-term success. Here’s how:

Monthly Action Plan

Make these steps part of your routine to track and improve EBITDA consistently:

1. Calculate and Track Your EBITDA Quarterly:

   • Pull your profit and loss (P&L) statement.

   • Add back interest, taxes, depreciation, and amortization to calculate EBITDA.

   • Compare results with previous quarters to identify trends and areas for improvement.

2. Focus on EBIDTA-improving activities:

   • Optimize pricing strategies (experiment with price increases for high-demand or premium offerings)

   • Identify opportunities for cross-selling to your existing customers

   • Streamline operations where possible and invest in automation of manual processes

   • Negotiate discounts from vendors

3. Document everything that affects EBIDTA

   • Keep clear records of unusual expenses

   • Track personal expenses run through the business

   • Note any family member salaries

💡 Quick Tip: Use a simple spreadsheet to log your EBITDA calculations and adjustments regularly. This will save time and ensure accuracy during due diligence. Alternatively, engage a professional CPA to keep the records clean and up to date for you.

Conclusion: Know and Grow Your EBITDA

Understanding and optimizing your EBITDA isn't just about better business metrics – it's about maximizing the value of your life's work. Every $10,000 improvement in EBITDA could add $30,000-$60,000 to your final sale price. This is real money in your pocket when you finally decide to realize the value you've built.

Summary:

• EBITDA, not revenue or net profit, determines your business's true value

• Legitimate adjustments can significantly impact your valuation

• Regular EBITDA tracking helps identify value-building opportunities

• Proper documentation of adjustments is crucial for credibility with buyers

• Industry-specific multiples determine your final business value

Next Steps

Whether you’re just starting to explore your exit options or ready to meet potential buyers, we’re here to help you guide your path forward.

Schedule a free confidential consultation with an OffDeal M&A advisor to:

• Understand your business’s current market value

• Explore actionable steps you can take to increase the value of your business today

• Learn about the current buyer demand for your business

Schedule call with OffDeal M&A Expert

OffDeal leverages advanced technology and expertise to help small business owners achieve the same quality of M&A service previously reserved for large corporations. Our mission is to ensure every business owner has the opportunity to maximize their value when they're ready to sell.