Normalised EBITDA: what it is and how it is calculated in a business sale

When a business sale is discussed, the first question you hear is almost always: “What is your EBITDA?” It has become the benchmark metric of the M&A world. Yet the “raw” EBITDA from the financial statements is rarely the one that really matters in a negotiation.

In this article I explain what normalised EBITDA is, how it is built and why it often makes the difference between a credible valuation and one that does not survive due diligence.

What EBITDA is and why the reported figure is not enough

EBITDA — Earnings Before Interest, Taxes, Depreciation and Amortisation — is the company’s gross operating margin before interest, taxes, depreciation and amortisation. It is used as a proxy for the ability to generate operating cash.

The problem is that a company’s financial statements, especially an SME’s, often contain items that do not reflect true recurring operating performance: above- or below-market pay for the owner or family members, personal costs run through the business, extraordinary income or costs, intra-group rents on non-market terms.

A buyer does not buy the past — they buy the company’s future ability to generate cash. That is why normalised EBITDA becomes the starting point of the valuation.

How normalised EBITDA is calculated

You start from reported EBITDA and apply adjustments — called normalisations o adjustments — to remove non-recurring or non-market items.

The most frequent normalisations in Italian SMEs are:

• Owner’s remuneration: if the owner pays themselves much less (or much more) than the market cost of a manager with the same role, the difference is adjusted
• Personal costs: cars, phones, travel and entertainment expenses with a significant personal element
• Intra-group rents: rents between related companies on non-market terms
• Related-party consulting fees: fees paid to family members or related companies for services that cannot always be evidenced
• Extraordinary costs/income: lawsuits, compensation, gains on the sale of assets
• Start-up or one-off costs: costs of opening new markets, reorganisations, transition costs

A practical example

Take a company with reported EBITDA of 800,000 euros. After normalisation:

• Owner’s remuneration: currently €50,000, market cost €120,000 → negative adjustment of €70,000
• Car costs and personal expenses: €30,000 → positive adjustment of €30,000
• Extraordinary lawsuit: €40,000 of costs → positive adjustment of €40,000
• Warehouse rented from the owner’s sister: €60,000 vs market €90,000 → negative adjustment of €30,000

Normalised EBITDA: 800,000 + 30,000 + 40,000 – 70,000 – 30,000 = 770,000 euros

The apparent difference is small, but at a 5x multiple the valuation changes by 150,000 euros. At higher multiples the impact is proportionally greater.

How many years of EBITDA are considered

In a sale, a single year is rarely considered. The most common approach is a weighted average of the last 3 years, with more weight on the most recent, or the figure for the last completed financial year if the business is growing.

When the business has been through periods of crisis or significant change, forward-looking projections based on a credible business plan are sometimes used. In that case, the quality of the business plan becomes decisive.

The role of normalisation in due diligence

A serious buyer — or their adviser — will carry out their own normalisation during due diligence. If the normalisations presented by the seller do not stand up to scrutiny, the negotiation gets harder and the price suffers.

That is why building a credible, documented normalised EBITDA before starting a sale is work that is worth its cost. It is not about “adjusting the numbers” — it is about presenting the company’s true performance so that an outside party can verify it and accept it.

The difference between a company worth 4 million and one worth 5 often lies right here.