What Is EBITDA? A Plain-English Definition for Business Buyers

Here's why. EBITDA measures the seller's earnings. Your only real question as a buyer is how much of that turns into your cash after you replace the owner and pay the loan.

So start with how it's built. Then look at the gap between their number and yours.

What it is and how you calculate it

It's operating profit with four non-operating costs added back, so you can compare the core earning power of one business against another before financing and tax structure muddy things up.

You build it off the income statement in one pass:

• Start with net profit, the bottom line after every expense.
• Add back interest. Debt cost is the owner's financing choice, separate from how the business runs.
• Add back taxes. The tax bill depends on structure and the owner more than on core operations.
• Add back depreciation and amortization, the non-cash charges for assets bought in earlier years.

What you get is a cleaner read on what the operations earn.

How it compares to net profit and SDE

Net profit is what's left after interest and taxes. EBITDA adds those back to strip out financing and tax decisions that change with every owner.

It's also different from seller's discretionary earnings, the figure most main-street deals actually trade on. SDE adds the owner's salary and perks back too, because in a small owner-run business the owner is part of the cost structure, not sitting above it.

And that's the catch EBITDA hides on a small business. It treats the owner's labor like it's free, so the headline overstates the cash that transfers until you take out what it costs to do the owner's job.

Rough rule of thumb: smaller owner-operated businesses get quoted in SDE, larger manager-run ones in EBITDA. Mix them up, or figure out how EBITDA and SDE split apart on a small business too late, and you'll end up comparing two numbers that were never the same thing.

Why buyers use it anyway

Because it evens out earnigns across businesses with different debt and tax setups. Stripped of financing, what does this operation earn? That's a fair question, and EBITDA answers it.

The trap is treating it as your take-home. EBITDA is the seller's earnings before two costs you inherit the day you sign:

• Owner replacement. If the owner did $90,000 of work, you hire a manager to do it, and that salary comes straight off EBITDA.
• Debt service. If you're financing through an SBA 7(a) loan, you repay it out of the cash the business actually produces.

Run both and EBITDA stops being a number you multiply and turns into a cash-flow question. Does what's left after a manager's salary and the loan payment clear the return you should want for the risk?

That one conversion is why two businesses with the same EBITDA can sell hundreds of thousands of dollars apart. The owner-light one hands a buyer more transferable cash and less owner to replace.

You can see the full conversion in how to value a small business as a buyer, where the EBITDA line becomes a cash-on-cash return you can defend. So next time a broker leads with EBITDA, ask him what the owner does all week.

FAQ

What is the EBITDA formula?

The EBITDA formula is net profit plus interest, taxes, depreciation, and amortization. You take the bottom line of the income statement and add back those four costs, which produces operating earnings before financing and tax structure are factored in.

Is EBITDA the same as profit?

EBITDA is not the same as profit. Net profit is what remains after interest and taxes are paid, while EBITDA adds both back, along with depreciation and amortization, to show what the core operations earn before an owner's financing and tax decisions.

Why do buyers use EBITDA to value a business?

Buyers use EBITDA because it compares earning power across businesses with different debt and tax structures. It is a starting point, not the buyer's take-home, because it sits before owner replacement cost and loan payments, both of which come directly out of that number.

EBITDA tells you what the operations earn. What the business is worth to you comes after you replace the owner and service the debt.

The Keystone diagnostic is built to run that conversion: 18 questions, about four minutes, and three scores plus your value range with the most likely figure locked, calibrated against 10 years of BizBuySell Insight Reports and 1.6M+ SBA 7(a) loan records.

Keystone is closed while the build finishes, so for now the door is a waitlist. Sign up at https://app.trykeystone.io. Keystone Command ($199/mo, $1,990/yr) adds the Deal Analyzer that runs the full buyer cash-flow conversion, and Core ($129/mo, $1,290/yr) tracks your own number as it moves.