Guest Blogger Steve Murray is the publisher of REAL Trends newsletter.

In our consulting practice on mergers, acquisitions, and valuations, we outline what EBITDA (earnings before interest, taxes, depreciation and amortization) means. It’s important because most of those doing the purchasing are using it as a proxy for how to value a residential real estate brokerage firm.

EBITDA is a measurement of the cash flow that a brokerage will produce for an owner or investor. It is commonly used throughout many industries as a way to measure what the business truly produces in terms of cash.

The second part of determining value is the application of a multiple to the EBITDA. It’s a question we get asked daily. EBITDA is used because a new owner needs to have a grasp on how much cash a brokerage produces to determine what someone can finance in an acquisition. While size, location, strategic value and other considerations are always at play, these factors are secondary to the determination of the level of EBITDA. These other factors will have an influence on the multiple of EBITDA that is used to calculate value. However, first every acquisitor is going to want to know what level of EBITDA the seller has before applying a multiple to the EBITDA to the final value.

In the brokerage business, there are other factors that are used to qualify EBITDA. First is an adjustment for owners’ benefits. In addition to quantifying EBITDA, we commonly add back all of the wages, benefits, and other items that the brokerage either pays to or pays on behalf of the owner of the brokerage. Then, we subtract what is referred to as Comparable Cost of Management, which is a measurement of what it would cost to replace the services provided by the owner. After all, a new owner may have to replace the existing owner(s) with new leaders, what will they cost? This, of course, varies depending on the location and size of the firm being valued.

Finally, we make adjustments for Non-Recurring Incomes and Expenses and add the net of these adjustments to base EBITDA. Non-recurring incomes could be one-time sales of property, a large legal settlement, the sale of a related mortgage or title company, etc. Non-recurring expenses vary widely and can include things such as the expense of closed offices, one-time costs for new offices, permanent reductions in salaries, employees, etc.

To get to the core EBITDA, one should start with earnings before interest, taxes, depreciation and amortization and then add the net effect of adjustments for comparable cost of management and non-recurring items. A few other notes. Interest expense is added back for operating loans and not for mortgage notes against a building that may be owned by the owner. The new owner is highly unlikely to assume any debt, so they will not have this expense going forward. Depreciation and amortization are added back because they are generally non-cash items.

While every owner wants to believe that their firm is worth more than some multiple of cash flow, that they have intangibles such as goodwill, brand name recognition and other intrinsic parts of the company, the fact is that virtually every purchaser of brokerage firms over the last 30 years relies first on EBITDA, or Adjusted EBITDA, to determine the core value of the firm.

This article originally appeared in the October 2015 issue of the REAL Trends Newsletter and is reprinted with permission of REAL Trends Inc. Copyright 2015.