Newburg | CPA News Brief
By David R. Natan, CPA, MST, CVA
March 28, 2023
Within the due diligence and valuation world, one of the more time-consuming areas spent by advisors pertains to helping recreate a company’s ‘normalized EBITDA’. Properly calculating this metric can often be a difficult and expensive endeavor, as internal accounting and finance teams for privately held companies typically do not calculate this important benchmark on an annual basis. If the information about the prior year is not fresh in the mind, the overlooking of key items will be prevalent. We often recommend that companies formally track this metric on an annual basis and integrate it just as they would any other important internal planning tool.
What is ‘Normalized EBITDA’ and How Do We Calculate?
EBITDA references earnings before interest, taxes, depreciation, and amortization, and is a widely used benchmark that represents a simplified view of a company’s cash profit. Normalizing this metric involves the process of eliminating non-recurring, irregular, or extraordinary expenses or items of income. Adjusting for these items helps reflect the true economic position and results of operations of your company and better represents the future earning capacity for a prospective buyer. The ultimate calculation starts with your pure EBITDA and simply adds or subtracts each normalizing adjustment to arrive at your ‘normalized EBITDA’ for the year.
Can You Provide Examples of Typical Normalizing Adjustments Made?
While not all-inclusive, we have included below some of the more common ‘normalizing’ adjustments to consider each year:
- Related party revenues or expenses that are not “arms-length” such as rent paid above or below market or management fee arrangements.
- Discontinued business operations
- One-time severance
- Lawsuit settlements and associated legal fees
- Moving expenses into a new facility
- Failed research and development if not common place to your business
- One-time regulatory rulings
- Write-down of unusual inventory that flowed through cost of goods sold
- Unusual gain or loss on sale of fixed assets
- Shareholder transactions impacting the P&L
- Out of period expenses/income – GAAP departures/methodology changes
- Generous defined benefit contributions (beyond a conventional plan)
- Normalizing owner/officer compensation to market
- Owner perks for meals, entertainment, memberships, key person insurance
- Key person insurance
How is ‘Normalized EBITDA’ Typically Used in Valuation and Due Diligence?
One of the most important measures when evaluating a potential acquisition or merger is the magnitude and nature of the business’ cash flow. From a sell-side due diligence perspective, the company will want to paint the most realistic picture for a prospective buyer in order to illustrate how their cash flows may add value in the future. Having a historical accounting each year of your ‘normalized EBITDA’ will go a long way in helping determine the appropriate multiple or purchase price to be used in pricing the deal. On the acquisition due diligence side, proofing your ‘normalized EBITDA’ becomes a key area of focus in providing the buyer with additional comfort on the transaction. Further from a valuation perspective ‘normalized EBITDA’ is a key metric utilized under some of the more popular market approaches. Methods such as the Market Comparable Multiple Method and Guideline Public Company Method integrate usage of ‘normalized EBITDA’.
In tandem with your internal year-end close process, we recommend generating a spreadsheet that calculates your ‘normalized EBITDA’ on a year-to-year basis. This could be one of the most important documents you maintain in your files on a go forward basis.
Newburg CPA, a mid-size accounting firm located just outside Boston, Massachusetts. We work with privately held businesses of all sizes helping them maximize their potential and navigate tax and accounting complexities at all stages of their business life cycle.
Interested in learning more about our services pertaining to accounting service work, business valuation and due diligence? Contact Newburg CPA today for a complimentary initial consultation at email@example.com and visit our website at www.newburg.com.
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