With private equity interest in medical practices continuing to increase, if you haven’t already heard the terms “EBITDA” and “Adjusted EBITDA”, you soon will.  Even if you’re not ready to sell your practice, it is still helpful to know what these terms mean and how they might one day apply to your business.  

Why do buyers care about EBITDA and Adjusted EBITDA?

It’s easiest to understand these terms when you consider the buyer’s perspective. EBITDA and Adjusted EBITDA are typically used as a tool to approximate cash flow from operations for someone acquiring a business. The buyer wants to have a clear view of how profitable operations are by removing the effects of one time, unusual, or discretionary expenses, financing decisions and accounting practices.  In essence, it’s the true, clean, operating profit of a business. When someone is buying a business, remember, they’re (usually) really buying the profit.  

First, What is EBITDA?

EBTIDA, or Earnings Before Interest, Taxes, Depreciation, and Amortization, is a metric that measures your practice’s performance before accounting for the effect of your financing structure and accounting practices. It gives the buyer a refined view of your profitability by taking your Net Income and adding back Interest Expense, Taxes Paid, Depreciation Expense, and Amortization Expense. The effect of these expenses has to be removed because they are heavily dependent on your tax environment, tax strategies, capital structure, and many other factors that are not the operations of your business.

What is Adjusted EBITDA?

Adjusted EBITDA further refines EBITDA by excluding non-recurring, irregular, or one-time items that are not representative of the practices regular performance. This is where the buyer can see how profitable the business is under their control, rather than yours. These adjustments can include:

• Owner’s compensation adjustments:
  • If you’ve been paying yourself above the market rate for your position, the excess above the market rate will be added to your EBITDA, increasing the value of your practice. If you’ve been paying yourself below the market rate, EBITDA will be adjusted down. This is because the buyer will either need to hire someone to replace you, or will need to pay you a fair wage.
• Personal expenses:
  • Personal expenses that have been run through the business will need to be added back to EBITDA. Travel costs, car leases, continuing education, and others are examples of costs that the buyer would no longer be paying after taking full control of the practice.
• Unusual or infrequent items:
  • One-time expenses/income are not representative of a practice’s regular operations, and are therefore removed from EBITDA. A pertinent example of this kind of add-back is any covid relief funds that might have been received during the COVID pandemic. Many practices received thousands of dollars that flowed directly to their bottom line. When valuing the practice, this income has to be removed from EBITDA.

Although EBITDA and Adjusted EBITDA are important factors to understand if you plan to ever sell your business, because they represent operating cash flow or profit, it’s nice to know these numbers even if selling is not in your near future. Increasing your EBITDA, and measuring how your EBITDA changes year over year can help you understand if your practice is maximizing profitability.  For more information about calculating your EBITDA or understanding your practice’s profitability, schedule a complimentary profit assessment with our team.

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