From the M&A Glossary: Add-backs

/in , /by Al Statz
Add-backs are adjustments made to a company’s financial statements to more accurately reflect its true earning potential and “normalize” its financial performance. These adjustments are typically made to the target company’s earnings before interest, taxes, depreciation, and amortization (EBITDA) to create a metric known as “Adjusted” or “Normalized” EBITDA.

Add-backs to EBITDA are expenses or income items that are considered definitional, discretionary, non-recurring, one-time, or not essential to the company’s core operations.

Common examples of add-backs include:

  1. Non-recurring:  These could include costs related to a lawsuit, restructuring, a natural disaster, or significant one-time investments.
  2. Owner’s compensation:  If the owner’s salary or benefits are higher than market rates, the excess may be added back to reflect the company’s true profitability.
  3. Discretionary expenses:  These are expenses that are not essential to the company’s operations, such as donations or excessive travel and entertainment.
  4. Non-arm’s length transactions:  These are business deals between related parties, such as family members, where the terms may not reflect fair market rates (e.g., real estate leases).
  5. Definitional: Interest, income taxes, depreciation and amortization are expenses that must be added back to net income to arrive at EBITDA

Properly normalizing financial statements is a learned skill that takes years of real-world M&A transaction experience. This is one of the many roles of an M&A advisor.