EBITDA: definition, calculation and adjustments for SMEs

Your accountant tells you the business made $400,000 in profit. A buyer looks at the same financial statements and calculates $700,000. Same company, same numbers — but not the same result.

The difference is normalized EBITDA.

It’s the first number a serious buyer will calculate when they open your file. And it’s often the number the owner doesn’t know — or underestimates — before entering a sale process.

What EBITDA is

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

It’s the central metric in business valuation.

Why? Because it measures the real earnings power of the business — before financing choices, tax structure, and accounting entries that vary from one owner to the next.

A buyer doesn’t want to know how much tax you pay or how you financed your equipment. They want to know how much the business generates from its operations.

EBITDA answers that question.

How to calculate EBITDA

The formula starts from net income — the number at the bottom of your financial statements.

You add back what accounting subtracted but that doesn’t reflect day-to-day operations:

EBITDA = Net income + Interest + Taxes + Depreciation & amortization

Let’s take a simple example.

Picture a Quebec manufacturing SME with revenue of about $5 million:

So far, that’s accounting mechanics.

But accounting EBITDA isn’t the final number yet. To compare valuation methods and set a defensible price, you have to go one step further: the adjustments.

Common adjustments for SMEs

This is where the reading changes.

In an SME, the financial statements reflect the owner’s choices — not necessarily the real earnings power of the business.

A buyer knows that. So does a lender.

What they want to see is normalized EBITDA: operating profit once you strip out items tied to the current owner or that won’t repeat.

Here are the three adjustments that come up most often in SME files. They don’t always increase EBITDA. In some files, the buyer will also make negative adjustments — for example if rent paid to a related company is below market, or if necessary expenses have been deferred.

Excess owner salary

Many owners pay themselves a salary higher than what a hired manager would cost to do the same work. That’s normal — the owner wears several hats.

In our example, let’s say the owner pays themselves $200,000 a year. A replacement general manager would cost about $100,000.

The $100,000 gap is an EBITDA adjustment.

Personal expenses run through the business

Personal vehicle, family cell phone, mixed-purpose travel — SMEs often carry expenses that run through the books but aren’t operational.

Let’s say $25,000 in our example.

Non-recurring charges

A lawsuit settled last year, an exceptional renovation, one-off consulting fees — these are expenses that won’t come back year after year.

Let’s say $15,000.

The result

We moved from $400,000 in net income to $700,000 in normalized EBITDA. The financial statements didn’t change. But the reading of the file is completely different.

EBITDA vs net income: the impact on value

The gap between net income and normalized EBITDA isn’t just accounting. It translates directly into the sale price.

In business valuation, you apply a multiple to normalized EBITDA to estimate enterprise value. That multiple varies by industry and company size.

Let’s revisit our example, with a conservative multiple of 4x:

$560,000 of gap. Without changing a single number in the financial statements.

This calculation gives an enterprise value. The final share price then also factors in net debt, working capital, and closing adjustments.

An owner who doesn’t run the adjustments doesn’t know what their business is really worth. And they risk entering negotiations with the wrong number in mind.

Why buyers look at EBITDA first

From the buyer’s point of view, net income carries too much noise.

It reflects your financing choices, your tax structure, your depreciation decisions — things the buyer will probably change as soon as they take the helm.

Normalized EBITDA, on the other hand, answers the question that matters: how much does the business actually generate from its operations?

That’s the number that determines:

• the price the buyer can defend
• the amount the bank is willing to finance
• the return the buyer earns on their down payment

When we model a transaction at RCA, normalized EBITDA is always the first number that goes into the model. Not net income. Not revenue. Normalized EBITDA.

If you want to know where yours stands and what it means for the value of your business, a confidential valuation is a good starting point.