The above pair of photos has been circulating on Twitter and are meant to depict Adjusted EBITDA versus Cash Flow — the suggestion being that sellers occasionally overrepresent the amount of cash their businesses generate by aggressively adding back expenses that are supposedly temporary or otherwise not representative of normal operations. Of course, this characterization is unfair. Most sellers and brokers strive to make an accurate representation of a company's earnings because they are honest people, and they are also aware that the truth will come out in due diligence.
This does not mean there are no gray areas. And because buyers, sellers, and bankers often think in terms of Adjusted EBITDA multiples, coming to an agreement on the Adjusted EBITDA can be a matter of some contention.
EBITDA is a straightforward calculation off of the Income Statement or P&L. The adjustments is where the controversy can come in. These adjustments, also commonly called "add-backs" though they are not always positive, are intended to provide "normalized" earnings. For example, if an owner is paying himself a salary that is above market rate, the portion of the salary above market rate could reasonably be added back.
A good practice when thinking about whether a given adjustment to EBITDA is reasonable to ask oneself, would another owner be able to run this business with similar success absent whatever the expense in question paid for? Making this more concrete, here are some broad guidelines: