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 net income (sometimes called “net profit”). But here is what most owners don’t realize: when it comes time to sell, buyers aren’t looking just at revenue or company’s net income – they’re focused on your EBITDA, a measure of your business’s true operating income and overall financial performance.

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

• Overestimating value by 300-400% when focusing on revenue, causing them to reject great offers

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

Understanding these financial terms might seem daunting – but it doesn’t have to be. In this article, we’ll teach you everything you need to know about measuring your business’s real operating profit and how to apply it when valuing your company.

In this article, you’ll learn:

• What EBITDA (Earnings Before Interest Taxes Depreciation and Amortization) really is and why buyers care about it more than other metrics

• How to calculate EBITDA from your financial statements

• Which adjustments can legitimately increase your EBITDA (i.e., how to arrive at your adjusted EBITDA)

• How to use EBITDA to estimate your business’s market or enterprise value

• How to increase your EBITDA margin (and the eventual sale price of your business)

What Is EBITDA? (And Why You Should Care)

EBITDA stands for Earnings Before Interest Taxes Depreciation and Amortization. It’s essentially earnings before interest taxes and key non-cash items, and it reveals your company’s true operating performance by stripping away factors that can vary widely between different companies. By removing interest expense, tax expense, and non cash expenses such as depreciation and amortization expense, EBITDA gives buyers a clearer understanding of ongoing cash flow potential.

Let’s look at a real example of how this EBITDA calculation shows why it matters:

Despite showing identical net profits, Company A is actually worth much more to buyers because its EBITDA margin (and absolute EBITDA) is higher. The differences come from:

• Bigger interest payments (which a new owner could refinance or avoid)

• Higher taxes (they might be in a different tax jurisdiction)

• Greater historical capital expenditures (leading to higher depreciation and amortization)

These factors hide the fact that Manufacturer A’s core company’s operations generate twice the cash flow of Manufacturer B.

Quick Tip: Your EBITDA can be 2–3x higher than the net income (or “net profit”) on last year’s income statement. Knowing your true EBITDA is crucial when talking to potential buyers, since it directly affects company’s profitability in their eyes.

How to Calculate Your EBITDA

To calculate EBITDA, start with your net income (or net profit) from your income statement, then add back four items:

1. Interest Expense: Separates core business results from financing or capital structure.

2. Tax Expense: Varies by legal structure (e.g., LLC vs. S-Corp) and does not reflect operating strength.

3. Depreciation: A non cash expense tied to tangible assets or capital expenditures that were paid for in the past.

4. Amortization: Similar to depreciation but for intangible assets such as patents or trademarks.

Hence the basic EBITDA formula is:

EBITDA = Net Income + Interest + Taxes + Depreciation + Amortization

Common Mistake: Don’t overlook interest expense on equipment loans, credit lines, or other debt. Properly capturing interest payments is essential for an accurate EBITDA calculation.

Making Adjustments to Your EBITDA

After calculating a base EBITDA, the next step is identifying legitimate adjustments to arrive at your adjusted EBITDA. These are primarily:

1. Non-Business Expenses: Personal or family expenses run through the business (e.g., family members on payroll, personal vehicles, or owner’s excessive salary).

2. Non-Recurring Items: One-time costs or revenue spikes that don’t reflect ongoing operations (e.g., legal settlements, major repairs, natural disasters).

Real-World Example: From Base to Adjusted EBITDA

Quick Tip: Keep a record of these adjustments (like gross profit, big add-backs, or unusual bills) in your cash flow statement so you can clearly demonstrate them to buyers.

Warning: Don’t be overly aggressive with add-backs. Buyers will ask for supporting documents, and every questionable “personal” or “non-recurring” item can undermine your credibility.

Using EBITDA to Value Your Business

When valuing your company, industry matters. Just like real estate in different neighborhoods trades at different price levels, different companies in the same industry might command a range of EBITDA multiples—for example, 3x to 6x. This multiplier is then applied to your adjusted EBITDA to derive an approximate enterprise value.

Consider a simple scenario:

• Similar businesses sell for 4–5x EBITDA

• Your adjusted EBITDA is $1 million

• Your business might be valued around $4–5 million

However, two plumbing companies in the same industry can still sell for vastly different multiples based on factors like customer diversity, recurring revenue, or company’s financial health.

Example: Two Plumbing Companies

Plumbing A commands a higher multiple because:

1. Predictable revenue from contracts

2. A broad customer base

3. Economic resilience—maintenance is needed regardless of the market

Quick Tip: An EBITDA margin consistently above your industry average can push you into a higher valuation range. Larger businesses with diversified customers and stable company’s financial performance also tend to get better deals.

Practical Steps: Making EBITDA Work for You

Improving and tracking EBITDA doesn’t have to be complicated. By following a few practical steps each month, you can monitor your company’s profitability, focus on operating profit gains, and enhance your eventual sale price.

Monthly Action Plan

1. Calculate and Track Your EBITDA Quarterly

   • Pull up your income statement and cash flow statement.

   • Walk through the EBITDA formula: Net income + interest + taxes + depreciation and amortization.

   • Note changes from the previous quarter to see if your EBITDA margin is improving.

2. Focus on EBITDA-Improving Activities

   • Optimize pricing (test incremental price increases for in-demand offerings)

   • Offer cross-sells or up-sells to existing clients

   • Automate repetitive processes and reduce operating expenses

   • Negotiate discounts on supplies to boost gross profit

3. Document Everything

   • Keep records of personal or non-recurring items to support your adjusted EBITDA

   • Track each depreciation and amortization expense carefully

   • Monitor big spikes in non operating income or unusual costs

Quick Tip: Ask your CPA to maintain a clear record of these items, especially if you plan to sell soon. Properly captured EBITDA data will smooth out due diligence.

Conclusion: Know and Grow Your EBITDA

Understanding and optimizing EBITDA is about more than metrics—it’s about maximizing the value of your life’s work. Every improvement of $10,000 to your EBITDA could add $30,000–$60,000 to your sale price once you apply typical multiples. That’s real money when the time comes to sell.

Summary:

• Legitimate adjustments (e.g., personal or non-recurring items) can significantly impact adjusted EBITDA

• Regular EBITDA calculation helps identify value-building opportunities

• Proper documentation is vital for credibility with buyers

• Industry-specific multiples (3–6x, 4–5x, etc.) ultimately determine your business’s worth

Next Steps

Whether you’re just beginning to consider a sale or actively meeting buyers, our team at OffDeal M&A is here to guide you:

• Understand your current EBITDA margin and company’s financial health

• Identify practical ways to grow EBITDA and your overall enterprise value

• Learn about current buyer demand in your same industry

Schedule a free, confidential consultation with an OffDeal M&A advisor to explore how to increase your EBITDA and achieve a premium valuation when you’re ready to exit.

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.