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What You Need to Know About Adjusted EBITDA
Why adjustments can make or break your financing application
Shaun Tiwari
April 29, 2025 • Estimated Reading Time: 8 minutes
When seeking business financing, many owners focus on revenue growth and profit margins. Yet lenders and investors are more interested in a different number – your EBITDA and its various adjustments. These calculations reveal your true operational performance and cash flow generation ability, which can make or break your financing or acquisition opportunity.
The True Language of Financial Decision-Makers
Banks, investors, and acquisition partners have learned through decades of experience that EBITDA-based metrics are better predictors of business sustainability than simple profitability.
A business with impressive net income but poor operational cash flow is like a sports car with a leaky fuel tank – impressive at first glance, but unlikely to go the distance.
Let's examine the critical differences between EBITDA and Adjusted EBITDA, and why understanding them gives you an edge both in securing financing and navigating acquisitions successfully.
EBITDA: The Starting Point
What it is: Earnings Before Interest, Taxes, Depreciation, and Amortization
Why it matters: EBITDA provides a clearer picture of operational performance by removing:
Interest costs (which vary based on debt structure)
Tax impacts (which vary based on jurisdiction and structure)
Non-cash expenses like depreciation and amortization
How to calculate it:
EBITDA = Net Income + Interest + Taxes + Depreciation + Amortization
Example: If your business has a net income of $3,000,000, pays $500,000 in interest, $1,000,000 in taxes, and records $1,500,000 in depreciation and amortization, your EBITDA would be $6,000,000.
Why lenders care: EBITDA approximates cash flow available for debt service, allowing lenders to assess your ability to make loan payments, regardless of your financing structure or tax situation.
Adjusted EBITDA: The Deeper Truth
Adjusted EBITDA takes standard EBITDA a step further by removing items that don't reflect the true operational performance of the business.
What it reveals: The normalized, recurring cash flow of the business without one-time, unusual, or discretionary expenses.
Common Acceptable Adjustments:
Owner compensation normalization - If owners take above or below market salaries, lenders will adjust to reflect what it would actually cost to replace them with professional management.
Example: A business owner paying herself $500,000 when market rate for her position is $1,500,000 would have a -$1,000,000 adjustment (reducing EBITDA).
One-time expenses - Truly non-recurring costs that won't affect future performance.
Example: Legal fees from defending a one-time lawsuit ($750,000) would be added back to EBITDA.
Family member salaries - Compensation for relatives not actively contributing value to the business.
Example: A $200,000 salary paid to an owner's spouse who rarely comes to the office would be added back to EBITDA.
Non-essential benefits - Discretionary perks that a new owner wouldn't necessarily continue.
Example: Country club memberships ($75,000) or personal vehicle leases ($40,000) would be added back.
Extraordinary items - Unusual gains or losses not expected to recur.
Example: Insurance settlement after a flood ($700,000) would be subtracted from EBITDA.
Red Flag Adjustments: Proceed with Caution
Not all adjustments are created equal. Lenders and buyers will scrutinize these proposed add-backs carefully:
Future cost savings - Theoretical efficiencies not yet implemented or proven.
Why it's problematic: These represent speculation rather than historical performance.
"Non-recurring" expenses that keep recurring - Items classified as one-time that appear regularly.
Example: Annual "restructuring" costs that appear every year for three consecutive years.
Pro-forma revenue adjustments - Increases in revenue that would have happened under different circumstances.
Why it's problematic: These adjustments often lack sufficient evidence and overstate potential.
Partial period adjustments - Extrapolating results from your best months across the entire year.
Why it's problematic: This ignores seasonal variations and presents an overly optimistic picture.
Adjusted EBITDA in Acquisitions: Where the Stakes Are Highest
In M&A transactions, Adjusted EBITDA takes on even greater importance, as it often serves as the basis for valuation multiples. Here are acquisition-specific considerations:
Transaction-specific adjustments:
Owner/seller salary and benefits - Normalizing to market rates for the role, especially important in owner-operated businesses where compensation may be artificially high or low
One-time transaction costs - Legal, accounting, and advisory fees related specifically to the deal
Redundant personnel - Identifying duplicate positions that would be eliminated post-acquisition
Facility consolidation - Potential savings from combining locations or operations
Synergy calculations:
Cost synergies - Quantifiable savings from combined operations, purchasing power, or overhead reductions
Revenue synergies - Additional income from cross-selling opportunities (these receive more skeptical treatment from buyers and lenders)
Quality of Earnings (QoE) reports:
Third-party validation - Independent accountants verify the accuracy of adjustments
Working capital analysis - Ensures seasonal or cyclical cash needs are properly accounted for
Customer concentration reviews - Identifies risks from over-reliance on few customers
Sustainable EBITDA calculation - Final adjusted figure that most accurately reflects ongoing business performance
How Lenders and Buyers View Your Numbers
Different stakeholders analyze adjusted EBITDA through different lenses:
Senior lenders (banks):
Conservative in accepting adjustments
Focus on debt service coverage ratio (typically wanting 1.25× or higher)
Require thorough documentation for all add-backs
May apply "haircuts" to certain adjustment categories
Subordinated lenders (mezzanine):
More flexible but charge higher interest rates
May accept future synergies with proper substantiation
Look at total leverage ratios (typically 3-5× EBITDA)
Buyers/acquirers:
Apply different multiples based on quality of earnings
Scrutinize seller-prepared adjustments intensely
Often prepare their own adjusted EBITDA calculations
Value consistency and predictability in historical EBITDA
Practical Applications: Putting Knowledge to Work
Whether pursuing financing or positioning for a potential sale, here are actionable strategies:
Document everything - Maintain detailed records supporting all potential adjustments, ideally right when expenses occur.
Be conservative - Better to under-promise and over-deliver than to have your adjustments rejected during due diligence.
Show trends - Demonstrate consistent improvement in your adjusted EBITDA over multiple periods.
Prepare your own QoE analysis - Don't wait for a buyer or lender to find issues; identify and address them proactively.
Segregate expenses - Use accounting systems to clearly track potentially adjustable expenses in separate accounts.
The Bottom Line: Master Your Metrics
Understanding the nuances between EBITDA and Adjusted EBITDA positions you to:
Secure more favorable financing terms
Achieve higher valuations in acquisition scenarios
Make better internal investment decisions
Focus management attention on truly value-driving activities
By tracking and improving these metrics before they're needed for financing or transaction purposes, you're building a more resilient, cash-efficient business that can weather challenges and capitalize on opportunities. That's the kind of business that both lenders and buyers will compete to finance.
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