Adjusted EBITDA: How It Is Calculated and Which Add-Backs Are Supportable

When preparing to refinance or sell your business, the earnings figure you present needs a clear explanation. A lender or buyer will want to understand which costs will continue, which items are exceptional and what supports each adjustment.

Adjusted EBITDA starts with earnings before interest, taxes, depreciation and amortization, then applies specific adjustments to explain the business's underlying operating performance. Supportable add-backs have a clear rationale and a traceable amount. The calculation must also reflect adjustments that reduce earnings.

You may also encounter normalized EBITDA. Here, that means an estimate of earnings under normal operating conditions. The labels are not used consistently, so two presentations with the same heading may contain different adjustments. Define the measure and its purpose before comparing the totals.

Start With the EBITDA Calculation

The basic EBITDA formula is:

EBITDA = net income + interest expense + income tax expense + depreciation + amortization.

Start with the income statement for a defined period and reconcile each component to the underlying accounts. Use the same period throughout.

Consider this hypothetical annual example, in Canadian dollars. All figures are teaching assumptions, including the replacement compensation and rent used below. They are not market benchmarks or a YLU CPA client result.

This example assumes no interest income or other complications in the basic bridge. The tax component is income tax expense; payroll, property, and sales taxes do not become EBITDA add-backs simply because they are taxes.

Depreciation may be recorded within several expense accounts. Reconcile the total once. Adding it again as a separate adjustment would overstate the result.

A Worked Adjusted EBITDA Calculation

Once the CAD 1,000,000 EBITDA subtotal is established, assess each proposed adjustment separately:

Adjusted EBITDA = EBITDA + supported upward adjustments − supported downward adjustments.

For this example, assume the following facts have been established for the same annual period. The business expensed its rent in the income statement, and its continuing occupancy terms support the assumed higher rent. No lease-accounting reclassification is needed.

The adjustment signs follow their effect on earnings. Removing an expense increases the figure. Removing a gain decreases it. Recognising a higher continuing cost also decreases it.

If the schedule included only A1 and A2, it would show CAD 1,180,000. Omitting the rent and disposal-gain adjustments would overstate this example's result by CAD 65,000. A complete bridge makes that difference visible.

If a lender or buyer does not accept the CAD 60,000 legal-cost adjustment, the figure would fall from CAD 1,115,000 to CAD 1,055,000, assuming the other adjustments remain unchanged.

Which Add-Backs Are Supportable?

A useful assessment asks what caused the item, whether it belongs in the period, and what the business will continue to earn or spend. Use the invoice to confirm the amount charged, then assess whether removing the cost gives a better picture of continuing earnings.

Owner Compensation and Occupancy Costs

For A2, the owner receives CAD 320,000, but the example assumes comparable work requires CAD 200,000 of replacement compensation. The adjustment is the CAD 120,000 difference. Removing the full salary would leave the necessary management work without a cost.

In a real analysis, compare responsibilities, working time, salary, benefits, and other compensation on a consistent basis. An owner paid below the cost of replacing their work could require a downward adjustment.

The rent row follows the same logic. The business currently records CAD 90,000, while its assumed continuing obligation is CAD 130,000. That extra CAD 40,000 reduces maintainable earnings. Non-market rent is a potential normalisation item, but the lease terms and accounting treatment must support the comparison.

One-Off Costs and Exceptional Income

A1 is supportable within the example because the dispute is assumed to be isolated and completed. In practice, retain the invoices, explanation of the matter and evidence of its resolution. Separate the exceptional component from ordinary legal work and account for any related recovery.

Assess regular contract advice, routine recruitment and ongoing maintenance by the business's continuing need for them, even when management describes them as discretionary. A cost can also be uneven from year to year and still belong to the way the business operates. Review the pattern across periods.

The same discipline applies to income. BDC's acquisition-financing guidance describes normalisation as removing non-recurring expenses or revenue. In A4, the adjustment removes the CAD 25,000 accounting gain already included in earnings. It does not deduct the equipment's gross sale proceeds.

Assess non-cash items by their nature, recurrence, and relevance to the earnings measure. Explain why the adjustment helps assess the business and apply that reasoning consistently.

Future Savings

Expected procurement savings, buyer-specific efficiencies, and revenue growth belong in a separately identified forecast or scenario alongside this historical bridge. State the assumptions, timing and costs needed to achieve them. Keeping that analysis separate lets the reader distinguish earnings already recorded from improvements still to be delivered.

Build an Evidence Record for Each Line

Supporting records help a lender or buyer assess the proposed adjustments and make it easier to resolve questions during the review. For each adjustment, retain:

• Source and amount: reporting period, account and transaction references, the recorded amount and proposed change, including any replacement cost.
• Supporting documents: relevant invoices, payroll records or agreements.
• Reason for the adjustment: how it reflects continuing earnings, including recurrence and assumptions about future operations.
• Review status: who assessed it, open questions, and whether it is proposed or accepted for the intended use.

For A2, link the historical compensation charge to payroll records and support the replacement estimate with the role description and compensation evidence. Clearly label the replacement amount as an estimate.

Use transaction references to check overlap. A legal invoice must not appear in both an isolated-dispute adjustment and a transaction-cost adjustment.

For public disclosures within their scope, Canada's non-GAAP disclosure rules require quantitative reconciliation and explanations. Use the checklist above as practical guidance for private transaction preparation; the applicable disclosure obligations depend on whether the company and disclosure fall within those rules.

Using the Figure in a Financing or Sale Discussion

The CAD 1,115,000 in the example is an earnings measure. It is not the amount available to repay debt.

Cash collection, inventory requirements, and supplier-payment timing affect liquidity. Capital spending, cash taxes, interest and principal payments also need their own analysis. BDC's explanation of borrowing capacity illustrates why debt-service calculations go beyond EBITDA and why lender definitions can differ.

For an existing facility, use the definition and permitted adjustments in the actual loan agreement when calculating a covenant. A management normalisation schedule does not establish covenant compliance. For a new financing request, distinguish the figure management proposes from the figure the lender agrees to use.

In an acquisition, the earnings bridge forms part of the wider financial due diligence review. For a borrower, it should connect to the forecasts and funding case developed during financing preparation. For a seller, organise the supporting records as part of business sale preparation, with disputed adjustments visible separately from the supported total.