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Small Business Valuation Example: From EBITDA to Discounted Cash Flow
How do you go from an owner's reported earnings to a supportable valuation analysis? Follow a fictional landscaping business through earnings normalization, a valuation-multiple illustration, free cash flow, and a five-year discounted cash flow (DCF) model.
Step 01 / Understand the company
The Case: A Privately Held Commercial Landscaping Business
Assume a founder-managed landscaping company serves commercial customers, employs operating crews, and owns some equipment. A buyer wants to understand the value of the operating business and the equity acquired. Every fact and amount below is fictional.
Annual revenue
Historical revenue in the example year.
Reported EBITDA
Before evaluating owner-related and unusual items.
Ownership & operations
Controlling interest; owner performs ongoing management duties.
What are we valuing? Two simplified perspectives: an operating enterprise value (cash-free, debt-free, assuming a normal level of operating working capital) and the corresponding 100% equity value. An SDE-based owner-operator analysis and professionally managed EBITDA analysis may require different comparable evidence and assumptions.
Step 02 / Owner compensation & normalization adjustments
Reconcile Reported EBITDA to Sustainable Earnings
Seller's Discretionary Earnings (SDE) reflects the economics before one working owner's compensation when defined consistently. Normalized EBITDA instead includes the ongoing cost of replacing the owner's necessary management functions. An adjustment is supportable only when backed by facts and not double-counted.
| Illustrative earnings reconciliation | Amount |
|---|---|
| Reported EBITDA | $260,000 |
| Add: Owner salary, benefits & employer costs already expensed | +$145,000 |
| Add: Supported nonrecurring legal expense | +$25,000 |
| Add: Supported personal expense charged to business | +$20,000 |
| Less: Nonoperating equipment-disposal gain | −$5,000 |
| Adjusted SDE | $445,000 |
| Less: Necessary replacement-management compensation | −$120,000 |
| Normalized EBITDA | $325,000 |
Assumptions: owner compensation and expenses do not overlap; the legal expense is demonstrably nonrecurring; personal expenses do not continue; the equipment gain is included in the reported EBITDA starting point; and $120,000 is an assumed all-in market cost for necessary management functions. Actual adjustments could move earnings up or down. SDE and EBITDA multiples are not interchangeable.
Step 03 / Illustrative market-multiple calculation
Translate Normalized EBITDA into a Preliminary Enterprise Value
For arithmetic illustration only, assume a 3.5× normalized EBITDA multiple. This is not a multiple derived from comparable-company transactions and is not a pricing recommendation for landscaping businesses.
Multiple-method enterprise value
Before excess cash, interest-bearing debt, or a negotiated working-capital settlement.
Illustrative 100% equity value
Includes the simplified enterprise-to-equity adjustments shown below.
| Enterprise-to-equity bridge | Amount |
|---|---|
| Operating enterprise value | $1,137,500 |
| Add: Excess, nonoperating cash | +$65,000 |
| Less: Interest-bearing debt | −$215,000 |
| Less: Assumed closing working-capital shortfall | −$30,000 |
| Illustrative equity value | $957,500 |
Working capital note: operating working capital is already assumed in the going-concern enterprise value. The $30,000 deduction applies only to the separately assumed closing delivery shortfall against a negotiated normal-working-capital target; it is not an automatic deduction from every enterprise value. Cash and debt definitions and treatment vary by transaction.
Step 04 / Introduction to free cash flow to the firm
EBITDA Is Not the Cash Available to Investors
Discounted cash flow analysis requires a forecast of economic cash flows. For a simplified, unlevered business valuation, we calculate Free Cash Flow to the Firm (FCFF) after operating taxes and reinvestment, but before financing payments.
Now assume Year 1 forecast results are as follows. Figures in the forecast exhibit are in US$ thousands, rounded for teaching purposes.
| Year 1 FCFF build ($000) | Value |
|---|---|
| Forecast normalized EBITDA | 351 |
| Less: Depreciation & amortization | (60) |
| EBIT (operating profit) | 291 |
| Less: Illustrative operating taxes (~25%) | (73) |
| Add back: Depreciation & amortization | +60 |
| Less: Capital expenditures | (68) |
| Less: Increase in operating working capital | (13) |
| Year 1 forecast FCFF | 197 |
The critical distinction: a company can report $351,000 of forecast EBITDA but generate only about $197,000 of unlevered free cash flow after operating taxes, capital spending, and working-capital investment. Debt principal and interest are deliberately excluded from FCFF; financing is reflected through the discount-rate and equity-bridge framework.
Step 05 / Discounted cash flow (DCF) valuation example
Discount Five Years of Cash Flow and Add Terminal Value
Assume a five-year FCFF forecast, a hypothetical 18% weighted average cost of capital (WACC), and a hypothetical 3% perpetual growth rate. Both rates are classroom inputs, not independently developed risk or growth assumptions for this company.
| Forecast ($000) | Y1 | Y2 | Y3 | Y4 | Y5 |
|---|---|---|---|---|---|
| EBITDA | 351 | 372 | 389 | 405 | 421 |
| D&A | 60 | 64 | 67 | 69 | 72 |
| Operating taxes (approx.) | 73 | 77 | 81 | 84 | 87 |
| Capital expenditures | 68 | 72 | 75 | 79 | 82 |
| Increase in operating NWC | 13 | 12 | 11 | 9 | 9 |
| FCFF | 197 | 211 | 222 | 233 | 243 |
| PV of FCFF at 18% | 167 | 152 | 135 | 120 | 106 |
Discount each forecast FCFF using: FCFF ÷ (1.18)year. The five present values total approximately $680,000.
Year 5 terminal value: $243,000 × 1.03 ÷ (0.18 − 0.03) = $1,668,600 at the end of Year 5.
Today’s terminal-value equivalent: $1,668,600 ÷ 1.185 ≈ $729,360.
PV of explicit 5-year FCFF
Forecast cash flows discounted to today.
PV of terminal value
Value attributable to periods beyond the explicit forecast.
Illustrative DCF enterprise value
FCFF present values plus the terminal-value present value.
All DCF figures are rounded to the nearest $1,000, or $10 where indicated, so minor rounding differences are possible. We use an end-of-year discount convention; no mid-year adjustment, nonoperating asset appraisal, market calibration, control adjustment, or transaction expenses are modeled.
Step 06 / Interpretation, limitations & practice
Why the Two Value Indications Differ
Our example produces an illustrative $1.14 million enterprise value using an assumed EBITDA multiple, and approximately $1.41 million using a five-year DCF. These are not independently supported valuation conclusions. The differences arise from differing assumptions, not because one method is automatically correct.
Illustrative EBITDA-multiple EV
3.5× is a hypothetical arithmetic input without comparable-sale support.
Illustrative DCF EV
Approximately 52% of the modeled EV depends on terminal value.
What a valuation professional must still do: substantiate normalized earnings, reconcile historical performance to forecasts, develop market-supported discount rates or multiples, examine working capital and CapEx, check data quality and risks, evaluate the purpose and standard of value, and reconcile reliable value indications with documented judgment. Simply averaging the two values would not create a defensible result.
Try Two Quick Calculations
Practice 1: What if the necessary replacement-manager cost rises to $140,000?
Adjusted SDE stays at $445,000, but normalized EBITDA becomes $305,000 ($445,000 − $140,000). At the same hypothetical 3.5× multiple, operating enterprise value becomes $1,067,500 before the equity bridge. This does not automatically mean the multiple should remain unchanged in a real analysis.
Practice 2: What happens if Year 1 capital expenditures rise by $20,000?
Holding everything else constant, Year 1 FCFF falls from approximately $197,000 to $177,000. The value effect depends on whether the extra spending is one-time maintenance or a recurring growth investment and whether it changes future cash flows.
Frequently Asked Questions
What is a DCF valuation in simple terms?
A discounted cash flow valuation estimates the present value of expected future economic cash flows. For an enterprise-value DCF, forecast FCFF is generally discounted at a rate consistent with the risks and capital providers reflected in that cash-flow measure, and a terminal value captures cash flows after the detailed forecast.
Why use FCFF instead of EBITDA in a DCF?
EBITDA omits taxes, capital expenditures, and changes in operating working capital. FCFF incorporates these items to estimate unlevered cash flow available to the firm's capital providers. These cash-flow definitions must be matched to the selected discount rate.
Can I use this model to price my own small business?
Only as an educational framework. The example uses fictional records and assumed multiples, WACC, growth, tax, and reinvestment inputs. Actual pricing and appraisal work require business-specific evidence, valuation purpose, ownership-interest analysis, and possibly professional assistance.
What is terminal value, and why is it important?
Terminal value estimates the economic value attributable to cash flows beyond the explicit forecast. It can represent a substantial portion of a DCF outcome; small changes in perpetual growth or discount rates can materially change it. Forecast maturity and long-run reinvestment must be economically consistent.
Does the full BVA course cover these calculations?
Yes. BVA's five-part program includes lessons on fundamental business valuation, normalization adjustments, owner compensation, free cash flow to the firm, capital expenditures, working capital, corporate taxes, forecasting, discount rates, intrinsic value, DCF, market methods, and transaction analysis. The course also offers models, templates, and professional reference resources.
Valuation Reference Library / Related Reading
Explore Related BVA Valuation Guides
Private Business Valuation Guide → SDE vs. EBITDA: Owner Compensation & Normalized Earnings → Business Valuation Multiples by Industry → Online Business Valuation Training & Curriculum →Important educational disclosure: This is an entirely fictional classroom example, not a professional appraisal, completed calculation of value, audit, Quality of Earnings engagement, tax opinion, investment recommendation, or indication of market transaction prices. All assumed earnings adjustments, market multiple, cash flows, discount rate, growth rate, tax rate, and working-capital convention are illustrative and must not be relied on for an actual acquisition, tax, financing, litigation, or ownership decision. Different facts and valuation standards can produce materially different results.