Now that we have a good baseline Earnings number we need to look at Interest, Taxes, Depreciation, and Amortization.
Interest Expense. The interest you can add back is all interest from debts and credit cards and consumer debts. It also can include finance charges. What interest does not include is bank fees, charges, or merchant fees. The interest you can add back is all interest that the new business owner would not have if he were paying cash for the business and had zero debt.
Taxes Expense. The taxes you can add back are income the taxes for the company. This add-back only applies to C-corps that you use a baseline number of Earnings After Taxes and not before taxes. If you use Earnings before taxes as a baseline number, then you don’t have to add back taxes for a C-corp. since the tax expense hasn’t been added to the Income Statement.
It doesn’t apply to S-corps or LLC’s or Partnerships. This includes all state and federal income taxes. It does not include payroll taxes, sales taxes, or local taxes. This is the tax your business pays. When you have an S-corp or Partnership the taxes flow through to the owners as individuals.
Depreciation and Amortization Expense. These can be found at the following locations on the tax returns and financials.
· Compiled, Reviewed or Audited Financials – look on the Statement of Cash Flow for the Depreciation and Amortization Expense if it is not shown on the Income Statement, Statement of Revenue and Expenses or Statement of Operations.
· Schedule C – sole proprietor – Line 13 and 27a for Amortization Expense
· Form 1120 – Line 20 or the Statement for Line 26 for Amortization Expense
· Form 1120S – Line 14 or the Statement for Line 20 for Amortization Expense
· Form 1065 – Line 16c or the Statement for Line 20 for Amortization
· Internally Generated P&L – Depreciation and Amortization are usually shown as line items expenses.
One item to note is Section 179 depreciation is not an item you add back.
These are the expenses you add back for a simple calculation of EBITDA. This is place where you start to calculate “Adjusted EBITDA”. In Part 3 of 3 this post I will cover Adjusted EBITDA, how it is defined, and how it is calculated and used.