Adjusted EBITDA introduces additional elements into the standard EBITDA calculation, subtracting all non-cash charges for share-based compensation, as well as other one-time expenditures. This approach is used to normalize the reported results of the companies included in 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. This means that the full calculation of adjusted EBITDA is as follows:
= Adjusted EBITDA
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.