EBITDA vs. Adjusted EBITDA and Why it Matters
By Tony Enlow, Managing Director, Transaction Advisory Services at BDO, a partner of M&A Leadership Council
Although compliant with US GAAP, the reported results of a potential acquisition target, often do not reflect the sustainable run rate of the company's cash flows. This article defines the difference between reported results and quality of earnings and how a quality of earnings analysis can potentially impact the purchase price and set the expectations of value of a potential acquisition.
Quality of Earnings (“Q of E”) in the context of a potential acquisition has a different meaning than quality of earnings from an audit perspective. Put simply, quality of earnings in a transaction environment represents the sustainable run-rate of earnings before interest, taxes,depreciation and amortization, or EBITDA, derived from normalization adjustments to reported results. Adjusted EBITDA is a critical element for buyers in building a valuation model and is often the basis for purchase price negotiations.
Acquisitions are typically priced based on a multiple of EBITDA. If EBITDA as reported is not critically analyzed and adjusted, the buyer may pay too much for the target, lowering potential returns and negating the value of potential synergies.
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