EBITDA is ubiquitous when discussing mergers and acquisitions, but it is also frequently misunderstood and miscalculated.
Some of the common misconceptions related to EBITDA include: ‘EBITDA is just a better version of net profit,’ ‘EBITDA equals cash flow,’ and ‘Depreciation gets added back, so equipment doesn’t really matter.’
“Yes, depreciation gets added back,” says John Joestgen, principal of JJ Landscape Consulting. “But sooner or later somebody has to replace that equipment. That cost will show up somewhere else, just not in EBITDA.”
Understanding EBITDA Versus Adjusted EBITDA
One area that commonly gets confused is the difference between EBITDA and Adjusted EBITDA.
“Regular EBITDA is pretty mechanical, and the numbers come straight off your financial statements,” Joestgen says. “Start with net profit and add back interest, income taxes, depreciation and amortization.”
Meanwhile, Adjusted EBITDA tries to show what a company normally earns by accounting for unusual or non-recurring expenses and other adjustments intended to reflect ongoing operations. This could be a legal bill or the owner takes a certain salary amount, but a qualified manager could be hired to replace him for 50% of that salary.
However, you can’t simply label anything as an add-back for your Adjusted EBITDA.
“If you’ve had the same ‘one-time expense’ for the last five years, you’re going to have a hard time convincing a buyer that year six will be different,” Joestgen says.
How EBITDA Factors Into Business Value
While EBITDA is one of the numbers most frequently used to help figure out the value of a landscape company, it is not the value of the business.
In many sales, the math is: EBITDA +/- legitimate adjustments = Adjusted EBITDA. From there Adjusted EBITDA × Negotiated Multiple = Enterprise Value.
It is the enterprise value that is the price of the business, before debt and other deal terms are settled.
The multiple a company receives varies greatly from business to business. It is based on your size, service mix, recurring revenue, growth, customer base, management depth, location, profit margin, employee retention, the economy and how many buyers are competing for your company.
Improving EBITDA is one way owners generate additional enterprise value.
For example, if a company’s legitimate Adjusted EBITDA is $1 million and a buyer agrees to a 6× multiple, the enterprise value would be $6 million. Yet if you improve your sustainable EBITDA by $100,000 and everything else stays the same: $100,000 × 6 = $600,000 of additional enterprise value.
Joestgen stresses enterprise value is not necessarily what will end up in the seller’s pocket.
“Paying off debt, how much cash and working capital the buyer requires you to leave in the business, deal expenses, earnouts (money paid later only if targets are hit), rollover equity (ownership you keep in the new company) and other deal terms can change what the seller actually takes home by a lot,” he says.
Avoiding Common EBITDA Calculation Mistakes
Joestgen says companies can also get tripped up calculating EBITDA when it comes to the basics of interest and depreciation. Owners shouldn’t add back the entire loan payment, only the interest. Paying down the loan itself is not an EBITDA add-back.
Depreciation can also be missed because it can show up under vehicle and equipment costs, overhead or several other places.
“Equipment purchases can also cause confusion,” Joestgen says. “I’ve worked with landscape companies that handled nearly identical equipment purchases differently from one year to the next. Sometimes they expensed the whole purchase that year, and sometimes they put it on the books and depreciated it. That changes both net profit and EBITDA.”
Neither practice is incorrect, but you need consistent accounting policies if you want your comparisons to mean something.
Joestgen says that a lot of these numbers can be tracked over time and AI can review results every month and flag anything unusual. This is another reason why consistency is important so the numbers being tracked can be measured accurately.
“Bad data is still garbage in, garbage out,” Joestgen says. “AI just gives you the garbage 10 times faster. Get the accounting and data set up right first. Then automate it.”
Recognizing What EBITDA Leaves Out
Joestgen notes that because EBITDA leaves out interest and depreciation, a business can have an attractive EBITDA while also having an aging fleet, too much debt, customers who are slow to pay, and very little cash.
“Depreciation on equipment you own gets added back in EBITDA,” he says. “Rental costs, and some lease payments, generally stay in as operating expenses. So two contractors can do basically the same work, one owning its equipment and the other renting or leasing it, and end up with different EBITDA.”
Joestgen stresses that while net profit, cash flow and EBITDA all provide a portion of the story, none of them tell you everything about your business.
