Adjusted EBITDA introduces additional elements into the standard EBITDA calculation, which is to subtract all non-cash charges for share-based compensation, as well as other one-time expenditures. This means that the full calculation of adjusted EBITDA is as follows:
= Adjusted EBITDA
This approach to EBITDA is used when there are differences in the compensation packages used by the various companies being compared as part of an industry analysis. The use of adjusted EBITDA is especially important when a business regularly engages in the use of stock options that comprise a significant part of the compensation packages of its employees, since the resulting expenses do not result in out-of-pocket negative cash flows for the business.
The formula can be adjusted further to include any unusual, one-time expenditures. In the preceding formula, we included one-time litigation expenses as an example of such items. These adjustments are made when a business wants to enhance its reported cash flows in order to maximize the valuation of the business – typically as part of an effort to sell the firm.
Adjusted EBITDA does not appear on an organization’s financial statements. Instead, the various elements of it must be extracted from a company’s financial statements and related disclosures, and assembled into the calculation.