Weighted EBITDA average calculation

April 25, 2022

by a searcher in Chicago, IL, USA

I have a deal I am working on where there EBITDA in 2018, 2019 and 2020 was $1M and the EBITDA in 2022 is $1.7M.
Could someone please offer their advice on how to approach the EBITDA calculation?

Is there a way that I can give more weight to the 2022 numbers but also take into consideration of the average of the previous years?

Any suggestions would be very much appreciated. Thank you in advance.

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Reply by a professional
from Victoria University of Wellington in New Zealand

What you're trying to do is use historical earnings as the best indicator of future earnings of course, it's the future cash flow discounted for risk that is the fundamental valuation formula. Firstly, there is no set rule, it's subjective. One answer is to weigh the most recent year by 50% and the 2-3 previous years by 25%/16%—but it remains subjective. I do lots of paid business valuations and in this case, I would quiz the owners about future revenue and EBITDA projections. If they are a form of recurring earnings then that adds credence to those projections, if much of it is in multi-year contracts then that adds further credence. If there is less volatility and more consistency that's more credence still. The more creditability the more likely to choose the last year of earnings, and the less credibility I average out the last 3-5 years.

You may want also want to forecast the next few years cash flow and use that as the basis of your analysis—if you feel you can make sensible projections. Not a tidy answer but this is a "messy marketplace" to quote Brent Beshore, or a "bizarre bazaar" to quote Robert Slee. I think there are a lot of opinions that masquerade as facts in our industry—this ain't theoretical mathematics with correct answers.

Reply by a professional
from University of Southern California in North Palm Beach, FL, USA

Warren Buffett says, “People who use EBITDA are either trying to con you or they’re conning themselves.” Charlie Munger, Buffett’s right-hand man, goes even further: “I think that, every time you see the word EBITDA, you should substitute the word ‘bullshit’" Strong words from some of the most successful businessmen on the planet.

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