How to Calculate EBITDA for a Business Sale | IBV™

EBITDA is earnings before interest, tax, depreciation and amortisation. It describes what a business earns from trading before three things are taken into account: how it is financed, what it pays in tax, and the accounting write-down of assets it has already bought. That is why buyers and lenders use it — it lets two businesses with different debt, different tax positions and different ages of equipment be discussed on something closer to equal terms.

It is worth being clear about what EBITDA is not. It is not a line defined by Australian accounting standards, and it is not a statutory reporting requirement. It is a measure of earnings, but it is not net profit after tax and it is not cash flow — its calculation should be clearly defined and reconciled to the accounts. A business can report healthy EBITDA and still be unable to pay its suppliers if customers pay slowly, stock builds up, or the equipment needs replacing. Because the measure is constructed rather than prescribed, two preparers can reach different EBITDA figures from the same ledger — usually over interest on related-party loans, lease costs, or what counts as an owner's pay.

For a business owner, the useful test is not "is this number high?" but "can a buyer, a lender or a valuer follow every step of how it was built?" A figure that reconciles back to the financial statements is a strong figure, even when it is lower than hoped.

Before adjusting anything, assemble the documents the calculation depends on:

• Financial statements for as many completed financial years as you have — five if possible, three as a working minimum — and management accounts for the part-run year if you intend to rely on them.
• The general ledger or trial balance behind the current year, so unusual entries can be traced rather than remembered.
• Depreciation and amortisation schedules, and the asset register behind them.
• Loan and lease agreements, with the interest component separated from repayments of principal.
• Related-party agreements: rent for premises, management or service fees, director loans, and any asset the business uses but does not own.
• The last two or three income tax returns, so differences between book profit and taxable income are visible.

If the accounts were prepared on a cash basis or as simplified trading income records, the gap between that statement and an accrual profit and loss can be large. Say so at the outset rather than presenting a reconciled figure that quietly assumes a different accounting basis.

Reported EBITDA is built from the bottom of the profit and loss upward, and the order matters because it is auditable:

1. Start with net profit after tax.
2. Add back the income tax expense for the period.
3. Add back interest expense on borrowings and finance leases. Do not add back principal repayments — those are not an expense.
4. Add back depreciation and amortisation charged in the period.

The result is EBITDA as the accounts stand. It has not yet been normalised, and for a closely held business it rarely survives unchanged.

Two safeguards keep the build honest. Add back an item only if it has already been deducted in arriving at the starting profit — if the accounts show profit before income tax, do not add tax again. Use the income tax expense recognised in the accounts rather than tax instalments paid, and state how interest income and other non-operating items are treated.

A second, independent build is worth the ten minutes it takes: start from revenue and work down through operating expenses, excluding the four items above and applying the same definition of income. A gain that sits inside reported earnings — the surplus-vehicle disposal in the example below — belongs in this route too, or the two builds will diverge because of inconsistent treatment rather than faulty arithmetic. If the two routes disagree, something has been double counted or omitted, and that is exactly the discrepancy you want to find before someone else does.

Check the lease-accounting basis before you compare anything. Some accounts deduct rent as an operating expense; others recognise right-of-use asset depreciation and lease interest under AASB 16. Adding those charges back produces a higher EBITDA than deducting rent as an expense, even though the underlying lease payments have not disappeared. Figures prepared on these different bases are not directly comparable: explain the treatment used, and keep it consistent with the multiple applied and any lease-liability adjustment.

Normalisation asks one question of each expense and each receipt: would a new owner incur or receive this? The adjustments that are usually tested are:

• Owner remuneration. Work from remuneration already charged as an expense in the accounts. Where the owner's recorded pay is below the supported cost of a replacement manager, earnings are overstated and the shortfall is deducted; adding back the owner's whole salary is rarely defensible, because somebody must still do the job. Drawings, dividends and loan withdrawals have not reduced reported earnings and cannot be added back. Accounts can report the owner's pay accurately and still understate the cost of replacement management — that is an earnings question, not a defect in the books.
• Other related-party salaries. A family member paid above the market rate for the role they perform reduces earnings, and the difference is added back. Where a new owner would outsource the role, the market cost of that service replaces the salary rather than disappearing.
• Related-party rent. Assess rent between the business and a related owner against commercial evidence, taking account of enforceable lease terms and the occupancy assumptions relevant to the valuation. Where premises are occupied below market rent, normalising toward market rent may be appropriate; where the business pays above market, the excess may be added back. Either way the arrangement must be disclosed, because a buyer needs to know what the premises will actually cost.
• Genuinely one-off items. A legal settlement, an insurance recovery, a fire or a one-time sale of a surplus asset may be removed in both directions, but not automatically. Separate exceptional recovery costs from the continuing insurance, security, maintenance or compliance spending that will keep arising. The test is whether the item recurs — not whether it is inconvenient.
• Personal expenses in the business. Vehicles, travel or subscriptions that serve the owner personally are added back, but only to the extent they are genuinely personal and only where the underlying invoices support the split.

A necessary business expense cannot simply be eliminated. Its amount may still need adjustment to reflect the ongoing cost under the valuation assumptions. Holding that line — adjust what a buyer will still incur, remove only what genuinely will not — is where most disputes over an EBITDA figure begin.

The following is a fictional illustration built to show the arithmetic; the business and the figures are invented.

Reported position for the completed year

Normalisation adjustments

The cyber add-back rests on stated assumptions: the $38,000 was expensed in the reported year, was not reimbursed, and excludes ongoing cybersecurity spending or capitalised expenditure.

Normalised EBITDA is therefore $352,000, about 14.7% of revenue.

Watch out: the management fee stays in. Stripping every related-party cost makes a schedule look aggressive; leaving in what a buyer would genuinely still pay is what makes the adjustments you did make credible.

Normalising reduced the figure. That is the point of doing it honestly: on this set of facts the business had been paying itself below market and under-charging itself for premises. Presenting $372,000 to a buyer who then discovers the true cost of the owner's role and the rent is a quick way to lose credibility in the middle of a negotiation.

First, trend it. If the prior two years' normalised EBITDA were $318,000 and $341,000, the three-year average is ($352,000 + $318,000 + $341,000) ÷ 3 = $337,000. A single strong year is evidence of a good year, not of a durable earning level. Nor is the average automatically the better answer: these results rise every year, so the analysis must establish whether that improvement is sustainable before $337,000 is preferred to $352,000. Review several years of normalised results alongside current trading, using monthly or quarterly information where seasonality matters — annual totals alone cannot show it — and let the selected earnings level reflect sustainable trading rather than an automatic averaging rule.

Second, apply the earnings to a test, not a formula. At a multiple of 4.0x, reported EBITDA of $372,000 implies $1,488,000 while normalised EBITDA of $352,000 implies $1,408,000 — an $80,000 gap created purely by the adjustments. The multiple itself must be supported by comparable evidence; a range quoted from a listing page or an industry table is a starting point for enquiry, not a conclusion. Our article on EBITDA multiples explains what to look for behind a published range.

Third, check what the figure assumes about the owner. If earnings depend on the owner's relationships, their hours, or a licence they personally hold, the earnings a buyer acquires may be lower than the earnings the business currently generates.

EBITDA sits above the real cost of keeping a business running. It ignores capital expenditure on replacement equipment, changes in working capital, the debt a buyer will have to service, and the tax position of the person receiving the proceeds. It says nothing about customer concentration, contract renewal dates, key-staff dependency, or whether goodwill transfers to a new owner.

Two businesses with identical EBITDA can therefore be worth materially different amounts. That is why a valuation is a defined engagement with a stated purpose, valuation date, basis of value and identified users, rather than a percentage applied to a single figure. EBITDA alone does not establish business or share value, and verifying an earnings figure is a different task from valuing a business. Where a transaction, tax provision, lender or dispute process does require a valuation, confirm the appropriate scope and reporting with the relevant adviser or recipient — the question is not whether EBITDA looks reasonable, but whether the conclusion is documented and supportable.

If you are preparing a business for sale or a finance application, present EBITDA the way a valuer would want to receive it:

• Show the build from net profit after tax, with each add-back named and sourced to a ledger line.
• Separate reported EBITDA from normalised EBITDA, and state every adjustment with the reason it is being made.
• Provide several years — five if you have them — so a buyer can see the trend rather than the best year alone.
• Disclose related-party rent, salaries and management fees before a buyer finds them in due diligence.
• Say what you have deliberately left in — such as a management fee a buyer would still incur — because it makes the adjustments you did make credible.

A well-prepared EBITDA schedule is often the strongest thing you can hand to a valuation process. The normalised earnings guide covers the same evidence question from the other direction: which expenses survive when a valuer tests them.

Keep the reasoning, not just the number. Every adjustment needs a document behind it — a payslip, a lease, a quote, an invoice. An adjustment that lacks support may be challenged, reduced or rejected during due diligence.

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