Why It Matters
Buyers, investors, and lenders use EBITDA rather than net income because it gives a cleaner picture of what the business actually generates from its operations. Two identical businesses can have very different net income figures depending on how much debt they carry and how aggressively they depreciate their assets. EBITDA removes those variables so businesses can be compared on equal footing. For an owner-operator, EBITDA is the foundation of valuation. When a buyer talks about a 4x multiple or a 5x multiple, they are applying that multiple to your EBITDA, not to your revenue or your net income.
How to Calculate It
The simplest formula starts from operating income and adds back depreciation and amortization:
In most small businesses amortization is minimal or zero. Depreciation is the more significant add-back. As an example, a business with operating income of $438,000 and depreciation of $45,000 has an EBITDA of $483,000.
What Owners Commonly Miss
The most common mistake is treating EBITDA as the final number that drives valuation. Raw EBITDA is the starting point. Buyers actually apply their multiple to Adjusted EBITDA, which is raw EBITDA after normalizing for owner compensation above market rate, one-time items, and personal expenses run through the business. The gap between the two can be significant enough to change the sale price by hundreds of thousands of dollars.