Holly founded ExitPromise.com as well as StartupPromise.com and so far has answered more than 3,000 questions asked by business owners about starting, growing and selling a business.
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The Definition of EBITDA: It is an acronym for Earnings Before Interest Taxes Depreciation and Amortization. EBITDA is often used as a measure of a business’s cash flow. Also it is used frequently in many business valuation formulas, depending on the business’s specific industry.
For example, the value of a business may be defined as a multiple of EBITDA. If the industry multiple is six (which would be very good), then the value of a business in such an industry would be six times the business’s EBITDA. Many other factors, not just industry type, impact the multiple applied to EBITDA for business valuation purposes.
How to Calculate EBITDA
To calculate EBITDA, start with the Net Profit shown on the bottom of the business’s Profit and Loss Statement, or alternatively the Taxable Income shown on the bottom of the business’s tax return. This is the Earnings figure or starting point.
Add to this Earnings figure the following:
- Interest Paid to banks, financing companies, vendors, supplier, lenders and the business owners;
- Taxes paid on the Income of the business. Do not add sales taxes paid or employment taxes paid on behalf of the business’s employees or employer-related payroll taxes;
- Depreciation deducted on the Profit and Loss Statement or Tax Return. If your business elected to take a Code Section 179
- Deduction on the tax return, this should be added as well; and
- Amortization deducted on the Profit and Loss Statement or Tax Return. The Amortization expense figure is usually found in Miscellaneous Expenses and is not shown separately on the first page of the tax return.
Learn more about EBITDA
EBITDA – What is its impact on when you should sell a business?
I believe my salary and draw plus the profit on the bottom line are included in sellers earnings. Can all add backs to the seller be included in earnings?
Hi Donna,
This post covers the definition of EBITDA which is not the same computation as what you are describing — Seller’s Discretionary Earnings.
EBITDA is traditionally used for large businesses while SDE is used for small businesses.
Here’s a post that covers Seller’s Discretionary Earnings, which may be helpful to you.
All the best…
I have a question about digital advertising taxes. We make a withholding tax payment to our government on the digital advertising service received from Google and this tax expense is currently included in marketing expenses. Is this tax paid considered operating expenses? Or should we exclude this tax expense from Ebitda?
Hello,
I am trying to calculate EBITDA from the 2019 tax returns for a Borrower. I was told by my credit department that we must use net book income on the M-1 as net income. If so, the depreciation amount on the tax return appears overstated versus the book amount. Which depreciation amount should I use for EBITDA then?
Hello, Lyn:
While I cannot provide tax advice through this forum for your specific circumstance, the general idea of a tax return is that the depreciation on the tax return matches the book depreciation only if books and records are using tax depreciation, which is indicated on the tax return itself.
If there is a difference between book and tax return methods, the differential is shown on Schedule M-1, EITHER on Line 5a or 8a depending on whether the difference is positive or negative.
Holly, I have a question regarding accrued payroll expenses. For 2016-18, I’ve had Payroll Accrual expenses on my year end P&L’s of 48K, 15K, and 94K respectively (a function, I presume, of the shifting of our bi-weekly pay periods, year over year). As I understand it, these are obligations incurred in one year, but paid in the following calendar year. Can these accruals be added back to EBITDA? Thanks!
Hi Ben,
I am sorry to say, generally speaking the answer is no.
The accrual of payroll expense allows your P&L to reflect the actual costs incurred and associated with actual revenue earned during the calendar (or fiscal) year. Simply said, it matches up all revenue earned with expenses incurred. And it’s very good if your financials are being created on the accrual basis of accounting!
However, if you are adding back any payroll expense for owners of the business who are being paid above-market compensation, then there may be some amount of the accrued payroll expense added back to compute Adjusted EBITDA.
Does this make sense?
I would like to ask for some further clarification on Section 179 Depreciation.
I am using our tax return as the source of data to calculate EBITDA.
If our company claims $30,000 for depreciation expense on our 1120S form, but we have another $150,000 claimed later for Section 179 Depreciation, would I add back the $30,000 and the $150,000 to compute EBITDA or just the $30,000 that was taken as an expense on form 1120S?
Hi Royce,
This is an excellent question Royce because when you have an S Corporation, the code section 179 depreciation deduction is not shown (or deducted) on the front of the 1120S tax return to get to the taxable income amount.
Instead, it is shown on the S Corp’s Schedule K-1 form. And that amount is applied as a deduction to the individual shareholders’ tax return.
So when you are calculating EBITDA for an S Corporation and you have code section 179 depreciation, you do not add it back to the net taxable income found on the bottom of page one of the 1120S.
On the other hand if you are working with the Profit and Loss Statement instead of the tax return, if the code section 179 depreciation deduction is included in the depreciation expense, then you would add it back to compute EBITDA.
Does this help?
You said “if” the 179 depreciation is included in the depreciation expense on the P&L statement, then you would add it back to compute EBITDA. What is the standard CPA practice whether or not to add the 179 depreciation on the internal P&L statement (even though it for sure will be listed on the 1120 corporate tax return)? Is there an IRS rule or CPS standards regarding this?
Hi Brian,
The calculation of EBITDA is not addressed by either the IRS or any CPA standards. And that’s because EBITDA is a measure used by Mergers & Acquisitions (M&A) professionals to understand how much cashflow is being generated by the business during a period of time (typically 12 months).
Whether you add back the depreciation expense recorded as a Code Section 179 depends on if you’re starting with Taxable Income from the tax return (Form 1120 or 1120S) or if you’re starting with Net Income from the P&L (internal Income Statement.
If you’re starting with the tax return’s Taxable Income figure, the Code Section 179 depreciation deduction has not been deducted to get to the taxable income amount. Accordingly, it would not be added back to Taxable Income to compute EBITDA. Code Section 179 deductions are recorded on the Forms 1120 and 1120S on Schedule K Line 11.
If you’re starting with the Net Income from the company’s P&L and the Code Section 179 was recorded on the books as a deduction, then the amount should be added back to Net Income to compute EBITDA.
As for standard CPA practice regarding the recording of Code Section 179 depreciation on the internal P&L, it’s important to understand whether the P&L is prepared according to GAAP standards or not.
GAAP standards require the P&L to be presented on the Accrual Basis of Accounting which differs from the Tax Basis of Accounting. Code Section 179 depreciation is a Tax Basis of Accounting expense.
So… whether Code Section 179 depreciation is recorded on the internal P&L depends on which basis of accounting is being used.
My CPA said EBITDA is GROSS profit. Your article calls it NET profit. He said after EBITDA adjustments what is left over that you can put in your pocket is NET profit.
Hi Joe,
With all due respect to your CPA, EBITDA is not Gross Profit.
Gross profit is the amount of money the sale of goods and/or services that remains after direct costs of providing those goods and/or services are deducted.
To compute Net Operating Profit, you take the Gross Profit and subtract all Expenses related to operating the business — think overhead expenses such as rent, utilities, admin salaries, etc.
EBITDA is an acronym that starts with EARNINGS and that figure is the NET OPERATING PROFIT of the business operation. Then we addback Interest Expense, certain Taxes, Depreciation and Amortization Expenses to get the business’ EBITDA.
I hope this clarifies things for you! If not Joe, let me know… All the best…
Hi Holly,
Got a quick questions for you. On the income statement, are the federal corporate taxes and state corporate taxes an add-back when calculating the EBITDA?
Ray
Hi Ray,
Yes, federal and state income taxes paid by the corporation are addbacks to EBITDA. These are the ‘T’ in the EBITDA acronym.
All the best…
Hello!
A lender I am dealing with regarding obtaining financing to develop a project is refusing to add back estimated depreciation for Year End 2017 in the calculation of EBITDA. Per most recent Financials, the depreciation is not part of the P&L 10/31/2017. In other words, it does not shown on the company’s P&L for the period 1/2107 thru 10/31/2017. The company’s CPA figures out depreciation at the end of the year to prepare the company’s corporate tax returns. This is heavy asset base business. I suggested to the lender to use 2016 deprecation per filed 2016 tax returns as the base of estimating 2017 depreciation for the first 10 months. And the lender still refuses to do that. There will not be any major changes from last year 2016.
Please let me know your take on this subject. Thanks !
Hi Jacques,
If the year-to-date Profit and Loss Statement for the company does not include an amount on it for Depreciation Expense yet, then it would not be appropriate to add the estimated 2017 depreciation expense to compute EBITDA. Doing so, would overstate EBITDA.
If on the other hand, the estimated depreciation expense is included on the P&L, then adding the depreciation expense back would be correct to compute EBITDA.
Either way, the EBITDA computation should be the same.
Hope this helps a bit…
I would appreciate your input on a matter involving Section 179.
As I am reviewing my client’s 2016 tax returns and Year end Financials for the same year, I have come to the understanding from various discussions with the owner of this aviation business, that the company’s CPA has advised the use of Section 179 in that year due to the fact that the company (S-Corp) made good profit that year. I can understand this, as I also understand that I can not add back the 179 deduction as it is after tax. I am using Year end 2016 Tax returns, as well as the Financials, in my recasting work sheet to calculate EBITDA. Financials do reconcile to the tax returns.
We are preparing the Company for sale, and I am wondering if the CPA’s advice was the right thing to do.
The asset ( Aircraft) was purchased for $430,000, and it was 100% not capitalized at all.
Surely, wouldn’t you want that 100% capitalized for depreciation purposes and higher ebitda?
The preparation of the business for sale has began just about 2 months ago.
It appears that the CPA has advised the use of Section 179 in another year for 2014, and 2015.
What impact would all of this have on ebitda recasting, if any?
Thank you kindly for sharing your insights.
Kind regards
Hi Jacques,
When calculating EBITDA, you would add back Code Section 179 as it is simply an accelerated form of depreciation.
It’s likely the CPA was minimizing the client’s tax obligations by electing CS 179. Technically, the tax return for the business would still reflect the $430K Aircraft as an Asset on the Balance Sheet. So, the asset would have been capitalized. When you take a CS 179, you don’t forgo capitalization, you’re simply accelerating depreciation expense for tax purposes.
And when preparing to sell a business, computing EBITDA is indeed very important! The Adjusted EBITDA for 2014 and 2015 should account for (or add back) the CS 179 deductions as well.
Yes, but only if it appears as a depreciation expense on whatever financial statements you are using. Typically S179 depreciation does NOT show up on financial statements (since it is added later to individual tax returns). Thus you typically would not add it back, because it wasn’t an expense in the statements to begin with.
In this case you can:
Income: $1,200,000
S179 Dep: $100,000
Other expenses: $1,000,000
Interest: $100,000
Net Income: 0
EBITDA: $200,000 (Addback both S179 and interest)
In this case you can’t:
Income: $1,200,000
Other expenses $1,000,000
Interest: $100,000
Net income $100,000
EBITDA: $200,000
In the second case S179 is added later to the tax return as a depreciation expense, but not on the company financials. If you added back S179 in the second case it would not be correct, your EBITDA would be $300,000, 100K too high.
The only time I can think to do this is if you are using his tax return as the source of the financial statements, or perhaps his accountant has provided you with tax-bases statements which include S179. Basically, if it is there, add it back. If it isn’t there, you can’t.
All Clear.
Thank you very much
It’s my pleasure Jacques!
You are correct Jacques.
If you are computing EBITDA from the tax returns, the CS 179 would be added back to income.
If you are computing EBITDA from the accrual basis financial statements, then the depreciation would not be the same figure used for CS 179. Instead it would be the GAAP Depreciation Expense and the GAAP Depreciation Expense would be added back to income to compute EBITDA.
Most of the time I find business owners have access to their tax returns and don’t always have their financial statements prepared on the Accrual Basis of accounting or according to GAAP.
Hi , my company is paying taxes withheld by Indian government when we bill our service fee to client (overseas) based in India.
Can I add back the taxes above to EBITDA?
Hi Evangeline,
Yes you should add any tax which is paid and deducted as an expense on the company’s P&L to compute EBITDA.