What is Adjusted EBITDA? Isn't it really just 'cooking the books?'

When we work with agency owners and agency buyers we often find line items that don’t belong in the P&L.

In addressing these items we can see a swing of up to 10% in the EBITDA-to-Gross Profit Ratio (that's both up and down).

Surprising? Maybe not.

Agency owners fight for every single % point gain and focussing on normalisations can reveal unexpected realities about profit.

Here’s how Adjusted EBITDA works to paint a clearer picture of your agency’s earnings by adjusting for one-off, non-recurring, or unusual items. When we present agency finances to potential buyers, we prioritize normalized EBITDA but also fully disclose any adjustments that have been made.

Here are a few things that we often see and consider addressing.

1.    Owners compensation adjustments

Some owners pay themselves from dividends or draw a tiny salary that is way off market norms. It may not be deliberate, but this presents a false position on profit.  We will always look to include a fair and reasonable salary into the P&L.

In a recent assignment the owners paid themselves via dividends. Adding real market salaries saw the agency profit go down by 7%.

2.    Extraordinary advisor costs

Legal and consulting fees for one-off projects—like acquisitions or major contract updates—aren’t part of everyday operations, so we exclude them.

For example, one client spent $20K revising legal terms, clearly not a “business-as-usual” expense and one that a new owner is likely to repeat.

3.    Market expansion costs

Expanding into new markets is a big deal, often requiring major cash outflows.

We recently adjusted EBITDA for an agency that funnelled funds into a new market. These costs don’t represent typical operations, so they’re removed from normalized EBITDA.

4.    R&D investments

This is similar to the one above in that a big non-recurring investment to develop some IP is justifiable.

Recently we worked with a team that developed a proprietary AI tool and had submitted an R&D claim to government that outlined the scale of the investment.

Where this gets challenging is when there is a recurring aspect to these costs. For this reason there will often be a discussion on what does and does not represent a fair profit adjustment for this.

5. Non-operational Income

Investment returns or asset sales should stay out of EBITDA since they don’t reflect core business performance.

6.    Management restructuring costs

Especially if the restructuring is non-recurring and intended to achieve long-term efficiencies.

One agency that we worked with removed an entire management layer reflecting a desire to create more efficiency but also to get closer to clients.

Clearly in this case it’s justifiable, but where this doesn’t work is if it’s costs related to the ebb and flow of agency wins and losses.

7.    Discretionary Expenses

This can sometimes be challenging, but there is an argument that items such as: staff bonuses and associated compulsory superannuation, personal vehicles, charitable donations, management fees to related parties and unusually high insurances could be candidates. Our rule of thumb here is: let's not take the piss!

For example: one advisor friend worked with an owner that wanted to reverse the costs of a failed marketing campaign on the basis that it was an unnecessary discretionary expense!

8.    I, T, D, A as cost lines.

Remember EBITDA is EARNINGS BEFORE interest, tax, depreciation, amortization. Sometimes these items can creep into the P&L thus understating profit. This is infact not a normalisation, more just a correction on the EBITDA calculation.

So, is Adjusted EBITDA “cooking the books”?

Only if done poorly.

At Agency Futures, we focus on defensible adjustments that show an agency’s true underlying profitability. While most buyers see the value in this, we aim to work with those who understand that normalised EBITDA is about transparency, not trickery.