2 February 2024 / Insight posted in Article

EBITDA (Earnings Before Interest, Tax, Depreciation and Amortisation) is one of the most common metrics used to assess how profitable a company is as well as cash generation. It is largely used as the basis for calculating the purchase price of company, whereby the enterprise value of a business is the result of an annual EBITDA, multiplied by an EBITDA multiple.

The multiple may be derived from recent transactions in comparable companies or listed comparable companies and is usually agreed when negotiating heads of terms.

However, for the EBITDA element, it is not quite as simple as presenting EBITDA per the latest statutory accounts, as this may include income and expenditure that is not in the ordinary course of business.

EBITDA is adjusted to normalise earnings for a typical year. Both buyer and seller should be aware of common normalising adjustments. These adjustments could affect the purchase price significantly with each being multiplied by the agreed multiple.


The enterprise value of Company A is £10 million, as EBITDA is £1 million, and a multiple of ten has been agreed. However, £80,000 of costs related to a redundancy. By adding this expense back (as it is not in the ordinary course of business) the adjusted EBITDA is now £1.08 million, and the purchase price £10.8 million.

Typically, the seller will discuss potential ‘quality of earnings’ adjustments with their adviser while drafting their information memorandum. They will of course want to maximise their EBITDA by removing one-off costs. These proposed adjustments are then subject to rigorous review during the buyside financial due diligence process, while the buyer’s adviser proposes additional adjustments that may reduce EBITDA.

Quality of Earnings

Common quality of earnings adjustments include:

  1. Exceptional expenditure: the seller may remove all one-time expenses that wouldn’t be incurred in a typical year.
  2. Related party transactions: this might be an arrangement that the company has with a related party that is outside of normal market terms, eg, they are charged less than market value rent. Post-completion, the company may have to pay full market rent, so the buyer will want this reflected in its cost base.
  3. Key management remuneration: if members of management are taking a lower-than-market-rate salary or shareholders are taking dividends as part of their remuneration, the buyer will want a market salary adjustment to reflect what will be paid going forward.
  4. Owners’/directors’ personal costs: if some expenses are for personal matters, the seller will want to remove these costs thereby increasing EBITDA.
  5. Discontinued operations: any costs and expenses relating to products or services that will not continue post-transaction are removed from EBITDA.

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