What Is EBITDA? A Simple Guide for Business Owners

If you've ever looked into selling a business, you've probably heard the term EBITDA thrown around. It's one of the most commonly used metrics in M&A — and one of the most misunderstood by business owners.

Here's what you need to know, without the jargon.

What Does EBITDA Stand For?

EBITDA stands for Earnings Before Interest, Taxes, Depreciation, and Amortization.

In plain English: it's a measure of how much cash your business generates from its core operations, before accounting for financing decisions, tax strategies, and non-cash accounting entries.

How to Calculate EBITDA

The formula is straightforward:

EBITDA = Net Income + Interest + Taxes + Depreciation + Amortization

Or, starting from the top of your P&L:

EBITDA = Revenue – Cost of Goods Sold – Operating Expenses (excluding interest, taxes, depreciation, and amortization)

Example

Let's say your business has:

• Revenue: $3,000,000
• COGS: $1,200,000
• Operating expenses: $1,200,000
• Depreciation: $100,000
• Interest: $50,000
• Taxes: $80,000
• Net income: $370,000

Your EBITDA would be: $370,000 + $50,000 + $80,000 + $100,000 = $600,000

Why EBITDA Matters in M&A

When buyers value a business, they almost always use a multiple of EBITDA. If your business has $600,000 in EBITDA and businesses in your industry trade at 4x EBITDA, your enterprise value would be approximately $2,400,000.

Buyers use EBITDA because it strips out variables that differ from owner to owner:

• Interest depends on how much debt the current owner carries — the buyer will have their own capital structure
• Taxes depend on the owner's personal tax situation and entity structure
• Depreciation and amortization are non-cash accounting entries that don't reflect actual cash flow

EBITDA gives buyers a cleaner view of the underlying cash-generating power of the business.

EBITDA vs. SDE: What's the Difference?

For smaller businesses (typically under $1-2M in earnings), buyers often use SDE (Seller's Discretionary Earnings) instead of EBITDA.

SDE includes everything in EBITDA plus the owner's total compensation (salary, benefits, perks). The logic: in a smaller business, the buyer is also buying themselves a job, so the owner's compensation is part of the earnings.

SDE = EBITDA + Owner's Compensation

As a rule of thumb:

• Businesses under $1M in earnings: Valued on SDE
• Businesses over $1-2M in earnings: Valued on EBITDA

The reason for the split is that larger businesses typically need a professional manager to replace the owner, so that cost stays in the expense column.

Adjusted EBITDA: What Buyers Really Care About

In practice, buyers don't just look at your raw EBITDA number. They calculate Adjusted EBITDA, which normalizes your financials by adding back expenses that wouldn't exist under new ownership.

Common add-backs include:

• Owner's personal expenses run through the business (car, phone, meals, travel)
• Above-market owner compensation (if you pay yourself $300K but a replacement manager costs $150K, the $150K difference is an add-back)
• One-time expenses (lawsuit, office move, equipment replacement)
• Non-recurring revenue (PPP loans, insurance payouts)
• Related-party transactions (paying your spouse or family members for roles that won't continue)

Adjusted EBITDA is what buyers actually use to determine the price they'll pay. Getting your add-backs right is one of the most important parts of preparing for a sale.

Common Mistakes With EBITDA

Overstating Add-Backs

Every owner thinks their add-backs are justified. Buyers are skeptical by default. If you're adding back $200K in "one-time" expenses every year, buyers won't buy it. Be conservative and honest with your adjustments.

Ignoring Capital Expenditures

EBITDA doesn't account for capital expenditures (CapEx). If your business requires $200K per year in equipment replacement or maintenance CapEx, your true free cash flow is lower than your EBITDA suggests. Buyers will factor this in.

Confusing EBITDA With Cash Flow

EBITDA is a proxy for cash flow, not cash flow itself. It doesn't account for changes in working capital, CapEx, or debt service. A business can have healthy EBITDA and still have cash flow problems.

Using EBITDA for the Wrong Size Business

If your business does under $1M in earnings and you're trying to market it on EBITDA, you're using the wrong metric. For smaller businesses, SDE is the standard — and marketing on EBITDA makes the earnings look smaller than they should.

How to Improve Your EBITDA Before Selling

If you're thinking about selling in the next 1-3 years, there are concrete steps you can take to improve your EBITDA:

• Cut unnecessary expenses that don't drive revenue
• Raise prices where the market supports it
• Improve operational efficiency to reduce COGS
• Eliminate personal expenses from the business P&L
• Invest in revenue growth — higher revenue at the same margin means higher EBITDA
• Negotiate better vendor terms to reduce input costs

Even modest EBITDA improvements can have an outsized impact on your valuation. A $100K increase in EBITDA at a 4x multiple adds $400K to your enterprise value.

The Bottom Line

EBITDA is the language buyers speak. Understanding your EBITDA — and more importantly, your Adjusted EBITDA — is the first step to understanding what your business is worth.

If you want help calculating your Adjusted EBITDA or understanding how buyers would value your business, let's talk. You can also learn more about SDE or explore valuation multiples by industry.