Will we ever see a normal level of normalised EBITDA?
Will we ever see a normal level of normalised EBITDA?
What is EBITDA/normalised EBITDA?
EBITDA is a key measure of business performance and a well-established cornerstone of transaction valuations. It is viewed as a proxy for operating cash flow, to which a multiple is applied to arrive at the enterprise value of a business. In a financial diligence process, much of my focus tends to be on assessing normalised EBITDA.
EBITDA stands for Earnings (i.e., profit) before Interest, Taxes, Depreciation, and Amortisation. By excluding interest, taxes, depreciation, and amortisation from the earnings, EBITDA provides a clearer picture of a company's operational profitability and its ability to generate cash flow from core business activities.
The use of a normalised or adjusted EBITDA measure seeks to adjust for the impact of a non-recurring event or a permanent change in a business to establish a robust basis for assessing ongoing trading.
What are common adjustments to EBITDA?
The most common adjustments we see depend on the nature of the business. Founder-owned and managed businesses often adjust for ‘lifestyle costs’ such as expenses that a different owner might not incur and a payroll that might not reflect arm’s length remuneration. A private equity-backed business might adjust for cost investments that are not yet mature in delivering their impact.
During an M&A boom, where there are more buyers than sellers, the list add-backs to EBITDA expanded - a higher level of EBITDA can justify a higher valuation and win a deal. We saw planned price rises and cost savings being suggested as adjustments. However, buyers are currently being sceptical in the more uncertain environment.
To assess normalised EBITDA, we tend to take a more sophisticated approach. So, as well as historical, normalised EBITDA, we typically look at:
Projections
If future revenue is visible and there is clarity of the cost base then analysis of projected performance might be helpful. However, evidencing the future is difficult at the best of times. for many businesses, there is still uncertainty around geo-politics, supply chains, borrowing costs and inflation. This is why building resilience into your business is so important.
Run rates
Annualising a recent period such as the last three months or a highly visible future period by incorporating an order book or pipeline can be informative as long as you remember to factor in seasonality.
Cash costs missing from EBITDA
Capital expenditure should always be considered. It is subject to accounting policy choices such as whether to capitalise development costs, so we look through the accounting to get to the underlying cash cost of maintaining EBITDA. The introduction of new accounting standards in the UK for periods starting 1 Jan 2026 muddies the water in that most operating leases (ie a monthly lease payment) will be brought on balance sheet, adding a right of use asset, with associated depreciation, and a lease liability, with associated finance charges. Depreciation and finance charges are not included in EBITDA. Investors will probably reverse these entries and replace them with a cash cost in EBITDA but companies need to be aware of this, as well as the related impact on reported debt.
Conclusion
Identifying reasonable adjustments to EBITDA is highly judgemental, with sector and deal experience critical to the assessment of potential adjustments. The same applies to adjustments to the equity value of a business: the enterprise value, plus cash, less debt, assuming a normal level of working capital.
The question of what the normal level of EBITDA is continues to evolve and there is no doubt that it needs careful consideration by both buyers and sellers alike.